Hello Friends. I recently refinanced on my second rental property and wanted to share the details for anyone considering doing the same. In an earlier article, I shared how to take advantage of equity growth and how to tap into that equity into an appreciating market. In that post, I shared some detail regarding the cash out refinance of my first rental and how it worked. Simply put, over 4 years, the property had appreciated nearly $100k and I wanted to convert that idle equity into cash that can be reinvested and create greater returns. After the mortgage was refinanced, I was able to pull out $26K as well as achieve a lower mortgage payment as a result of the lower rate (3.5% vs. 4.3%).
Immediately after closing that refinance, I began working on a second refinance for my other single family home. Initially intending for it to be a cash-out like the one before, I learned that while it had appreciated quite a bit in the year and a half that I had it, after paying closing costs and paying off the balance of my original loan, rather than getting cash out, the primary benefit was a lower mortgage payment (which means more cash flow). Here is how it worked.
I bought the property in July of 2019 for $115k. At the time of initiating my refinance, I believed it was worth $145k (and still do). However, It was appraised at $138k, which still is not bad. The value of the property increased by $23k, or 20%. With my mortgage balance of $95.5k, I went from 20% equity (at the time of closing) to 30% equity in the property in a relatively short time. However, unlike my first refinance, this would not be a substantial enough increase in equity to pull out a large amount of cash. But I did discover an opportunity just as great.
Recognizing how high the rate was for my original mortgage, 5.36%, compared to the new rate, I would have, 3.6%, I knew that the lower rate mixed with the smaller increase in equity, I could get a lower mortgage payment than what I had. This would improve monthly cash flow, which I was very interested in doing after having recently added the monthly expense of property management (check out the post here). So I continued the process and here is how the numbers worked out.
With the appraised value of the house of $138k, the new lender would issue me a loan with a 75% loan to value. That means my new loan would be $103,500. With my current mortgage balance of $95.5K, there would be about $8k left over for closing costs. Closing costs turned out to be $6.3k, which means I would have some pocket money at the closing table. But here is where the real benefit was.
My new mortgage payment would be $721 compared to the original $888. That is a reduction of $167 a month, or 20% improvement to cash flow! Doing that math, based on the original investment of refinancing costs and fees, and accounting for the improvement to cash flow, this is an effective return to investment of 31%.
I will show some basic math below:
Old Mortgage Details
Rate: 5.36%
Payment: $888 (includes tax and insurance)
Balance: $95.5k
New Mortgage Details
Rate: 3.6%
Payment: $721 (includes tax and insurance)
New Balance: $103.5k
Financing/Closing Details
– New mortgage: $103k
– Pay off old mortgage: -$95.5k
– Closing costs: -$6.3k
– $ at closing: $1.2k
– Other costs: $450 (appraisal)
– Net proceeds: ~$750 (pocket change)
Cash Flow Benefit/ROI
– Old Payment: $888
– New Payment: $721
– Cash Flow Improvement: $167 (18.8%)
– Initial Investment: $6300+$450
– Return: 167 per month over 30 years (360 payments)
– Effective return (using financial calculator) – 31%
Why do I share all of these numbers and details? To show you the power of math in decision making. Looking at it from a cash out standpoint, I did not get much cash like l did last time. But with the benefit of lower rates, I was able to take advantage of the opportunity for a lower mortgage payment, which was very beneficial after having just committed to paying extra for property management as I prepare to scale my real estate portfolio.
Whether you are an active investor or a passive investor, using the numbers to help guide your decision making is beneficial. As Brandon Turner from the Bigger Pockets Real Estate podcast once put it, “Use Math to Overcome Your Fear.”
Until next time and safe investing!
