One of the key things to remember in refinancing an investment property is to evaluate what the cash flow level will be after you refinance, assuming that you are already cash flowing out of the property.
An example:
You originally bought a $100,000 property that cash flows at $250 a month with a $429 loan payment. (30 year fixed rate at 5% with a 20% down payment for a principle of $80,000). After five years, through improvements to the property and appreciation, the property is now worth $150,000. The bank will give you up to 80% equity in the new loan. So after five years, you have $76,537 equity in the property:
- You have paid down the original mortgage to $73,463
- The value of the property is now $150,000
- $150,000 – $73,463 = $76,537
Thus, the bank will give you $61,230.
If you add this new amount to the balance of the original mortgage, your new loan is $134,693 ($61,230 + $73,463) for a payment of $723. Thus, your positive cash flow of $250 becomes a negative cash flow of $44!:
- The new payment minus the old payment gives us a difference of $294:
- This difference minus our cash flow gives us a negative cash flow of $44:
You may want to consider not refinancing the full 80%. If you merely did 50% you would still get to withdraw $38,268.50 tax free while incurring a new payment of $600 allowing you continue cash flowing at $79 a month:
- Your new loan is $111,732 ($38,269 + $73,463)
- Thus, your new payment is $600
- Thus, your cash flow is $79
o $600 - $429 = $171
o $250 - $171 = $79
Remember, that tax free money equates to $76,537 in earned income since by the time all is said and done, earned income is taxed at 50%.
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