Refinance Magic – Putting Equity to Work
[Guest post by “K. Money!”]
What if I told you that I could increase the production value of your rental property by 10-20% and I will PAY YOU $4,600 to do it, does that sound like something you’d be interested in!?
Now you are probably thinking……
“This sounds like some kind of reverse ponzi scheme!”
“I could use the $4,600 to buy tickets to Fyre Festival 2021!”
“Am I being Rick Rolled?”
No, you are not being Rick Rolled. This is a real deal I just completed. Besides, no one is more trustworthy than Rick… 🙂
I currently own an investment property duplex at 67% loan to value on a standard Fannie Mae 30 Yr fixed rate mortgage. I used the BRRRR (Buy, Rehab, Rent, Refinance, Repeat) strategy on this investment property 3 yrs ago w/ a $325k appraisal after rehab. Here is what the mortgage currently looks like:
Existing Mortgage Details:
- Remaining Balance: $217,546
- Interest Rate: 4.625%
- Monthly P&L: $1,169
- Annual Principal Gain: $4,406
Not too shabby right? It was a historically low rate at the time. I remember thinking that there was no way I would ever refinance this property w/ a 4.625% mortgage rate on a cash-out investment!
Yet here we are. This is the new rate I am approved for and locking in:
Refinance Loan Details:
- Total Financed: $236,000
- Interest Rate: 2.95%
- Monthly P&L: $988
- Annual Principal Gain: $4,968
2.95%!? Now that’s what I am talking about!
I love that interest rates are an integral part of a real estate investor’s ego. We just love to tell others about it.
I immediately told my wife the good news. She looked at me a moment without expression and said “Did you walk the dog yet?”
Disappointed, I immediately called a friend (while walking the dog) “Yeah, that’s right man!…. I am a 2.95% guy now! If you want to chat to my lender, I suppose I co….” My friend cut me off. “I just got 1.99% on my house.” I hung up. What a jerk.
Now is a good time to point out that a primary residence enjoys a lower interest rate than a rental property loan. Rather than explain this to my friend, I just decided never to speak to him again.
Costs to refinance the duplex:
Here are the refinance costs to break my current mortgage and start the new one:
- Interest Rate Buydown (Points): $6,936
- Fees (Title, Tax, Admin, etc): $3,119
- Lender Appraisal: $675
- Prepaid Interest: $290
- Total Borrower Refi Cost: $11,020
That seems like a lot, but I didn’t pay for any of these costs out pocket. If I had to pay out of pocket then I would have never done the deal. I could have, but I can make much higher returns than 2.95% investing elsewhere so it doesn’t make much sense to pay $11k out of pocket.
Instead, I had enough equity in the property to take on a larger mortgage to cover the $11k in closing costs. This is a great way to put the latent equity in your property to work for me.
So my equity is paying for the refi right now, but it is still an expense that I have to pay back eventually. It should happen naturally over time with rental income covering my lower mortgage payments.
Is the juice worth the squeeze? What is the upside here & how long will it take for this refi to pay for itself?
My lower mortgage payment nets me an increase in cash flow, plus an increase in debt paydown every month vs. my existing mortgage!
- Net Annual P&L Cash Flow Increase: $2,172
- Net Annual Principal Increase: $561
- Approx. Payback Period on Refi (Yrs): 2.36
I definitely do not plan on getting rid of this asset in the next 2-3 yrs so refinancing to this lower interest rate is a no brainer!
WARNING! – ADDITIONAL NERDY ANALYSIS AHEAD. PROCEED AT YOUR OWN RISK…
Now here is a fun tip if you really want to make your friends jealous of your interest rate. You can buy a lower interest rate if you want! You may have noticed that my closing fees seem super high. One of my expenses is “Interest Rate Buydown” and at $7k it is nothing to scoff at. This is a one-time fee to lock the 2.95% interest rate. Here were some of my rate options and their costs:
So why did I choose 2.95%? Why not choose the lowest mortgage interest rate?
I have a lot of latent equity in this property that I can’t do anything with so I wanted to put that equity to work for me. Buying down the rate as much as possible and paying the fee with the mortgage itself is a good way to do that. Keep in mind, the higher my closing costs, the longer my payback period – even with a lower monthly mortgage payment. (Ex: at 2.65%, it is a 3 yr payback period for the refi) The cost starts to increase exponentially the lower the rate gets.
For me, just under 3% seemed like the sweet spot.
I haven’t forgotten that I mentioned I got paid $4,600 to do this deal. While this is true; it isn’t the full truth. It is more like I structured the new mortgage so that I could exchange some more equity for extra cash!
The new mortgage requires that I fund a new escrow account to pay for the next years’ homeowner insurance & property taxes. Once again, I could fund this account with my own cash but instead I increase the mortgage amount using the equity in the property to do so.
Prepaid Escrow Account: $4,005
Out of Pocket Costs?
- Appraisal: $675
- Cash Due to Me @ Close: $3,429
- Old Mortgage Escrow Refund: $1,824
- Total Cash in Pocket: $4,578.71
When all is said & done, I walk away with some money I can use to fund another real estate investment that will make me much more than 2.95%!
Would you have done this deal? Have you refinanced a rental property loan recently? What kind of rate did you get? (It is ok to share. This is a safe space. No one will judge you… Unless they have a better interest rate.)
*Photo up top by Breno Assis