Let's Get Some Cash Out Baby: The Basics of a Cash Out Refinance

With sincerest apologies to Katy Perry - we thought it was important to let beginning investors know about a way for them to free up their capital enabling them to buy additional properties.

It can be very frustrating when you are just getting started in investing.  You see a multitude of good opportunities all around you but you only have so much cash for a down payment.  Once you have purchased a property or two your cash is then tied up in the property and you can't get it out.

One way to free up that capital is called a cash out refinance.  Once you have paid down the mortgage enough or the property has increased enough in value, you can exchange your old mortgage for a new one.  The trick is that now you have more equity in the property you can receive the additional amount of the loan above and beyond what you need to pay off the old loan in cash.

That way you can get your initial down payment out of the property and use it to buy another one.  Then you literally have put no money into the investment and your return on a zero investment is looking exponentially better.

How does this look in real life?

Let's say you purchase a property for $100,000 and put 10% down ($10,000).  Then over the course of a few years the property increases in value to $140,000 and you have paid an additional $5,000 down on the principal of the loan.  So the loan is sitting at $85,000 and you have $55,000 worth of equity.

You can do a cash out refinance and replace your old mortgage of $85,000 with one for $100,000.  After paying off the old loan there is $15,000 left that goes straight to you as cash.  You can then make your next investment.

There are risks involved with this of course.  If the property goes down in value you have taken out a lot of your equity.  So it is important to do this when the property value has made a solid and stable increase in value.

In addition, there are fees associated with refinancing so you have to weigh those in to your decision.

Plus, lenders are getting much more strict about doing these refinances.  You need to show that you have a 25% Loan to Value (LTV) ratio before they will let you take any cash out.  Furthermore you will have to pay for the appraisal fee to show that the property has increased in value enough to justify the Loan to Value ratio.

This is just another tool to be aware of as you try to maximize your ability to acquire more properties at the right time.