So following the closing and renting out of our most recent rental property, I decided to refinance the home that we live in (our primary residence) because rates were so low. I didn't know anything about refinancing other than I could get a lower rate so it seemed to make sense to do it.
Because this was the first time I refinanced anything, I learned a lot. Mainly that it is a bit more than just doing some paperwork to get a lower rate... which is what many real estate guru's would lead you to believe. So I figured I'd share what I learned with you in case you are a newbie at it like myself. For those who aren't, sorry if I'm stating the obvious (but honestly, this was not obvious to me before I started the process).
Photograph by Alice Pasqual
Here's what you should know if you are thinking about refinancing a property:
Refinancing does cost money. It's like taking out an entire new loan. While there aren't as many costs as when you originally purchase a house, many of them you do incur again. For example: another appraisal is needed in order to close the refinance. While you don't have to come to the closing day with cash, know that the closing fees and additional costs are folded into your future loan. So say you are refinancing a loan for 225k that you still owe, your new loan may end up being 231k but at a lower rate because the extra fees are folded into it.
Do the math to make sure it is worth it. This is tough because it requires that you have a game plan for the property. In our case, we love our home and plan to hold on to it forever (god willing) so the numbers made sense. We refinanced into a 30 year mortgage and although it would take a few years to pay back the closing fees on the refinance, over time the lower rate would more than pay for itself, thus making the refinance make sense. If we didn't intend to stay as long, it might not have been worth it. Or if the rate wasn't low enough, again, the closing costs might not have offset the gains made by a lower rate. So take the time and do the math to figure it out. If you are unsure how to calculate it, have your broker talk you through the different options. That is what a broker is there for, to help you find the best deal possible out of all the loans that are out there!
Your term limit starts over. I thought maybe since I purchased the home 4 years ago, that it would leave 26 years left on the mortgage (I originally used a 30 year mortgage), however it does start over. So my new loan now is 30 years long. Decide if that works with your investment plan. You can also refinance into a shorter loan if you prefer that. Sometime it's worth it, sometimes it's not. For us the difference in rates was so minimal that it just didn't justify going to the 15 year mortgage. Additionally, we still plan on buying some more investment properties in the next few years so having a longer payback on our primary home lowers the amount we are paying each month, which frees up extra cash to go into buying more investment properties and building our portfolio. Again, there is no right or wrong answer, but make sure you choose a term limit that fits with your investing goals.
You can used a refinance as a way to get money out and use for other things. Many people do this to get cash to reinvest in another property or to finance the renovation on the property. You can usually refinance a loan up to 75% of the value of the house. Keep in mind though, the money isn't free. Your monthly payments will be larger. What a cash-out-refi means is you are paying off your smaller loan and taking out a larger loan. The difference is the appreciation of the property allows you tap that equity.
Sometimes the numbers don't make sense to do that, although, sometimes they do. Again, it comes back to your goals. If you are still in the acquisition phase of building your portfolio, this may be a great idea. If you are now trying to pay off all your properties so you have more cash flow this could be a step backwards. And, sometimes, if you don't run the numbers before you may cash out and refinance and then realize your property no longer cash flows, thus turning it into a liability! So just be careful because if you are looking to refinance in order to get equity out of a property you will still end up having a monthly payment that is higher to pay back what you removed. It's not just free money out of thin air.
Bottom line is it's a resource for you and it could be the solution to scaling your investments. It also could be a step backward in some situations. Always do the math and make sure it's worth it. If you are not sure how to do the math, ask your broker to help and talk you through the different calculations. You can also bring your questions to a meet up or a mastermind group and have fellow investors help you to analyze and figure out the numbers. Don't just take a leap of faith and assume because you could end up regretting it and it could set you back a few steps on your investing journey. Always make sure strategies like this align with your goals as an investor.
Here are some different strategies people have used depending on their investment preferences:
If you are a person who prefers cash flow, this could be a way to increase your cash flow and reduce your monthly payments (however it will spread them out over a longer period of time).
If you are someone who is looking to build equity and pay off your loans quicker, this might be for you if you avoid taking cash out and continue to pay the same amount on towards your monthly payment. With a lower rate, it will pay down quicker.
If you are looking to grow your business faster and you are a little more comfortable taking on leverage you can use the BRRR method. BRRR essentially means: Buy, Rehab, Rent and Refinance. Many people use the money they refinance out of a house to buy another project. This is what propels their quick growth but leaves properties highly leveraged.
For me, I chose to refinance our primary residence because the rate is so much lower. I will use the extra money I save each month on that now to pay down quicker another property I have with the higher interest rate. Sometimes when you get such an amazing rate, it doesn't make sense to pay it off early. This is the case here. And also sometimes the leverage acts as a buffer zone against lawsuits. It can be a part of your asset protection plan. Its harder to successfully sue an LLC that has a property with very little equity than one that is paid off...
There is no right or wrong answer when it comes to how you use a refinance to build wealth. It all depends on your goals and your numbers. So try different scenarios, role play with them and run the numbers. Whatever outcome is best, go for it! And sometimes the best outcome is not to refinance at all because it won't save you money in the end. That is okay too.