Cash Out Refinance To Buy Second Home
The BRRRR Strategy:
“Buy, Renovate, Rent, Refinance, Repeat,” is a real estate investment strategy that allows investors to acquire properties, improve them, and then refinance them at a higher value to pull cash out and repeat the process.
In this blog post, we will discuss two common ways to access the equity in your home: a Home Equity Line of Credit (HELOC) and a Cash-Out Refinance. We will also introduce the BRRRR strategy, a popular real estate investment approach that allows investors to acquire properties, improve them, and then refinance them at a higher value to pull cash out to acquire another property. We will run through some real life BRRRR examples later on in the post!
A HELOC is a revolving line of credit that allows you to borrow against the equity in your home. It works much like a credit card, with a credit limit based on the value of your home and the amount of equity you have. You can borrow as much or as little as you need, and you only pay interest on the amount you borrow. HELOCs typically have variable interest rates, which means your payments may fluctuate over time.
On the other hand, a Cash-Out Refinance involves taking out a new mortgage to replace your existing one. The new mortgage is for a larger amount than your current mortgage, and the difference between the two is paid out to you in cash. This cash can then be used for a variety of purposes, such as home improvements, debt consolidation, or other large expenses. Cash-Out Refinances usually have fixed interest rates, meaning your monthly payments will remain the same over the life of the loan.
Key Differences: HELOC vs. Cash-Out Refinance:
Interest Rates:
- HELOCs generally have variable interest rates.
- Cash-Out Refinances typically have fixed interest rates.
Loan Terms:
- HELOCs have a draw period and a repayment period.
- Cash-Out Refinances have a fixed loan term (usually 15 or 30 years).
Access to Funds:
- With a HELOC, you can borrow and repay funds as needed, up to your credit limit.
- With a Cash-Out Refinance, you receive a lump sum of cash at the time of closing, and you cannot borrow additional funds unless you refinance again.
Closing Costs:
- Both HELOCs and Cash-Out Refinances may have closing costs associated with them.
- The closing costs for a Cash-Out Refinance are typically higher, as they involve the costs of originating a new mortgage.
The BRRRR strategy, which stands for “buy, renovate, rent, refinance, repeat,” is a real estate investment strategy that allows investors to acquire properties, improve them, and then refinance them at a higher value to pull cash out and repeat the process.
The first step of the BRRRR strategy is to find a property that can be purchased below market value. This can be done by searching for foreclosures, short sales, or properties that need significant repairs. Once the property is acquired, the investor will renovate it to increase its value and make it more attractive to renters.
The next step is to re-rent the property at a higher rate than the monthly mortgage payment. This will create positive cash flow, which can be used to pay for the renovations and other expenses.
Once the property has been stabilized and is generating positive cash flow, the investor can refinance the property at a higher value than what was originally paid. This will allow the investor to pull cash out of the property, which can then be used to repeat the process and acquire more properties.
The BRRRR strategy is a great way for investors to grow their real estate portfolio and create long-term wealth. However, it does require a significant amount of capital and knowledge of real estate and renovation to be successful.
Let’s go through a couple hypothetical examples of the BRRRR strategy, using some realistic numbers:
Initial Purchase Price: $300,000
Down Payment (20%): $60,000
Renovation Budget: $20,000
Total Investment: $80,000
Now, let’s assume that the property’s value increases by 20% after renovations. This would bring the new value to $360,000 (based on the appraised value – yes, you need to get the property appraised as part of the process).
New Appraised Value: $360,000
Next, you’ll need to determine the loan-to-value (LTV) ratio for refinancing. A common LTV ratio for investment properties is around 75%. This means that the maximum loan amount would be 75% of the new appraised value, or $270,000.
Maximum Loan Amount: $270,000 (this is the refinanced “cash out” you get)
However you still have to subtract the existing mortgage balance from the maximum loan amount to determine the net cash-out amount. In this case, let’s assume the existing mortgage balance is $240,000 (remember, we put of 20% down ($60k) on the $300k purchase price).
Net Cash-Out Amount: $270,000 – $240,000 = $30,000
Now, subtract the cash-out amount from your total investment to see if you can recover your entire down payment.
Total Investment (down payment + reno costs): $80,000
Cash-Out Amount: $30,000
Remaining UN-recovered initial Investment: $50,000
In this example, you would not be able to recover your initial investment of $80k (down payment + reno), as the cash-out amount is only $30,000. To break even and recover your full down payment, you would need a higher percentage increase in property value after renovations.
For example, if the property’s value increased by 40% after renovations, the new value would be $420,000. Using the same LTV ratio of 75%, the maximum loan amount would be $315,000. Subtracting the existing mortgage balance of $240,000 would result in a cash-out amount of $75,000.
Cash-Out Amount: $315,000 – $240,000 = $75,000
Did we get our full initial investment back this time?!
Total Investment: $80,000
Cash-Out Amount: $75,000
Remaining UN-recovered initial Investment: $5,000
Not too shabby! In this example we recovered our full down payment of $60,000 and most of our renovation costs, meaning we could repeat another BRRRR (e.g. maybe we put in a bit more sweat-equity this time to make up for the $5k less of reno budget). Keep in mind that this example is simplified and doesn’t include closing costs, taxes, and other factors that can impact the actual numbers. But as you can see, the BRRRR strategy is legit – though the “perfect” BRRRR is not all that easy. It requires finding the right undervalued property and a good deal of involvement to improve it such that it can be reappraised for a sufficiently higher value (e.g. as much as 30-40% more than what you bought it for).
In conclusion, both HELOCs and Cash-Out Refinances offer homeowners a way to access the equity in their homes, while the BRRRR strategy provides real estate investors with a powerful method to acquire, renovate, and refinance properties for long-term growth. The best option for you will depend on your individual financial situation, your goals, and your preferences. Be sure to carefully consider the pros and cons of each option before making a decision.