Creative Finance 201: How to Cash-Out Refinance to Fund Real Estate Deals
Cash-out refinance is a process of refinancing your existing mortgage loan for a higher amount than what you owe and receiving the difference in cash. For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, you can refinance your loan for $250,000 and get $50,000 in cash. You can use this cash for any purpose you want, such as paying off debts, making home improvements, or investing in other properties.
In this article, we will show you how to use cash-out refinance as a creative financing strategy for real estate investors.
What is Cash-Out Refinance and How Does it Work?
A cash-out refinance is a way to access cash by replacing your current mortgage with a new, larger loan. The difference between the new loan amount and the balance on your previous loan goes to you at closing in cash, which you can spend on home improvements, debt consolidation or other financial needs.
To get a cash-out refinance, you need to meet certain criteria, such as having a good credit score, a low debt-to-income ratio, enough equity in your home, and a stable income and employment history. You also need to compare the costs and benefits of refinancing your loan, such as the interest rate, fees, closing costs, and the impact on your monthly payments and taxes.
A cash-out refinance can be used as a creative financing strategy for real estate investors who want to leverage their existing home (or investment property) equity to fund more profitable opportunities in different markets or niches.
For example, you can use cash-out refinance funds to rehab fixer-uppers and sell them at a higher price after making improvements, buy distressed properties at below-market prices and hold them until they appreciate or generate rental income, flip houses by buying low-cost properties in need of repairs or renovations and selling them quickly after fixing them up, buy seller-finance or subject to, or invest in commercial properties by buying office buildings, retail spaces, warehouses, or landfills and renting them out or developing them further.
How to Qualify For a Cash-Out Refinance
Not all properties are eligible for cash-out refinance. You need to meet certain criteria to qualify for this type of loan. These criteria include:
Having a good credit score (at least 620)
Having a low debt-to-income ratio (below 43%)
Having enough equity in your home (at least 20%)
Having a stable income and employment history
Having a clear title and no liens or judgments on your property
4 Benefits of Doing a Cash-Out Refinance
Some of the benefits of doing a cash-out refinance are:
You can increase your home equity by taking advantage of the appreciation in your home value.
You can lower your interest rate by switching to a more favorable loan term or type.
You can access more funds for your real estate investments without taking on additional loans or mortgages.
You can use the cash for any purpose you want, such as paying off debts, making home improvements, or investing in other properties.
5 Risks of Doing a Cash-Out Refinance
You will have to repay the new loan with interest, which may increase your monthly payments and total cost of borrowing.
You will reduce your ownership stake in your home and extend the life of your mortgage, increasing the total amount you are leveraged.
You may lose some tax benefits if you use the cash for non-mortgage purposes or if you sell your home before refinancing.
You may face higher closing costs and fees than a regular refinance.
You may have to pay a higher interest rate if interest rates have increase since you initially purchased the home.
Terms You Should Know Before Doing a Cash-Out Refinance
Home equity: The market value of your home minus what you still owe. For example, if your home is worth $300,000 and you have $100,000 remaining on your loan, you have $200,000 in home equity.
Loan-to-value (LTV) ratio: The percentage of your home’s value that is financed by your mortgage. For example, if your home is worth $300,000 and you have a $240,000 mortgage, your LTV ratio is 80%. Lenders typically limit the maximum LTV ratio for cash-out refinances to 80% or less.
Closing costs: The fees and expenses you pay to finalize your mortgage, such as appraisal, title, origination, and recording fees. Closing costs can vary depending on your lender, loan type, and location, but they usually range from 2% to 6% of your loan amount.
Interest rate: The annual cost of borrowing money from your lender, expressed as a percentage of your loan balance. The interest rate determines how much interest you pay over the life of your loan and affects your monthly payment amount. The interest rate for a cash-out refinance may be higher than a rate-and-term refinance, depending on your credit score, LTV ratio, and market conditions.
Points: Fees paid to your lender at closing in exchange for a lower interest rate. One point equals 1% of your loan amount. For example, if you pay one point on a $200,000 loan, you pay $2,000 upfront to reduce your interest rate by a certain amount, usually 0.25%. Points can help you save money in the long run if you plan to keep your loan for a long time, but they increase your closing costs.