A Cash-Out Refinance in the COVID Era
If you’ve been paying attention at all to the mortgage market these days, you know that interest rates are at a low and the refinancing market has been insane.
This situation has its pro’s and con’s.
While the interest rates are low, lenders are tacking on fees left and right to profit, as well. Also, I suspect the volume of refinancing right now has made the service level drop quite a bit.
About 2 years ago, Josh and I sat down and wrote out our financial plan. Part of that plan was to downsize and pay off my student loans quickly.
Then, we planned to save up a downpayment and buy a primary residence in New York first with a great debt-income ratio.
Then, we had planned to cash out refinance our rental property, which has gained a good bit of equity, so we could reinvest that gain in another income-generating property.
(As an aside, generally, I’m very debt-averse. I would never take out more debt to buy a boat or another depreciating toy. But, I’m ok with taking out debt on an investment property to buy investment real estate since it is an income-generating asset, rather than an expense.)
Well, everything was going according to plan really until COVID hit. The pandemic complicated our primary residence buy only slightly.
But, then the real snag came when it was time to cash-out refi the rental.
There was a period between the spring and summer when banks stopped doing cash-out refi’s all together. I guess they had so many primary refi requests, they didn’t need to do cash-outs. So, I hit a wall there. I got around it by regularly going on some local real estate Facebook groups and looking for local credit unions doing cash-outs. Luckily I found a few by mid summer.
But first, there are a few ways to put equity in a property to work. Two options might be considered here: a cash-out refi a HELOC (Home Equity Line of Credit). You may ask why Josh and I did a cash-out refi and not a HELOC?
The Difference Between a Cash-Out Refinance and a HELOC
In a cash-out refinance, a borrower is basically taking out a new mortgage with new terms, and paying off the old mortgage. If it’s a fixed-rate mortgage like ours, the interest rate is locked in for the life of the loan. Banks will generally lend up to 75%-85% of the home’s appraised value. So, basically, we’re taking some of the equity out of the property with a new loan. The new loan has closing costs similar to those associated with buying a primary residence.
Home Equity Line of Credit
A HELOC is a revolving line of credit based on the equity in the home. Like a cash-out, it has closing costs. But, a borrower can use the credit as they need it. The downsides are that it is usually set as a variable rate, may have balloon payments built-in at the end of the loan that may require a borrower to borrow more money, and may have periodic fees associated with keeping the line of credit open, even if a borrower isn’t using the HELOC.
Here is more good info about Cash-out Refi’s and HELOC’s by the Federal Trade Commission.
Back to our story
So, during the pandemic, with the interest rates so low, I wanted to lock them in for the life of the loan and get the cash out to re-invest in another cash flowing rental.
And I’m happy to report, we were able to lower our interest rate from 3.635 to 3.375% (investment property interest rates are generally a point higher than primary home rates) and get equity out of a property we didn’t pay anything down for. That basically means we can turn one rental into two and double our rental cash flow.
As an added bonus, we were able to do it before the new Fannie and Freddie “adverse market” fee kicked in. This might have cost us another $1400.
The Process of Getting a Cash Out Refinance
Here was the process:
I talked to several loan officers at local credit unions and negotiated the best I could.
Once we agreed on terms, we decided to proceed and they pulled our credit report.
We signed a bunch of forms and sent them all our financial info.
Then, the home was appraised and our loan amount was adjusted based on that appraisal. We were lucky to have the home appraised for higher than we thought). We paid the appraisal fee ($500) up front.
Then, the loan went into underwriting and the title company did the title search.
An important difference between this refi and our other home purchases is that we didn’t have a lawyer representing us. I kind of wished we had in the end, but I think we made it through ok.
Another important difference was the provision in the loan that said that if we defaulted, the lender could take over the lease of our current renters and collect rent from them. I guess that makes sense.
Finally, the closing was scheduled and a notary was sent with all the papers for us to sign.
Then, the title company disbursed the funds to pay down the original mortgage and sent us the rest.
The Glitches We Encountered
However, we encountered quite a few snags in this process. The biggest piece of advice I have for you is to read each and every closing disclosure carefully and get the negotiating hashed out before the closing date. Watch the numbers and the fees that are tacked on. I caught quite a few errors during this process that could have cost us a lot of money.
Here are a few things we ran into:
The loan took a long time to close because of delays in paperwork and underwriting. This was probably due to the high volume of refinance requests and work at home conditions. But, every time our “interest rate lock” expired, a new interest rate lock extension fee was tacked on to our closing disclosure. I had to call several times to get that taken off since the delay was not on our side.
Similarly, our original loan payoff amount changed from the original closing disclosure to the last one since the closing took so long (we continued to make payments to our old loan and our principal decreased). That wasn’t adjusted until I requested a new payoff estimate from my bank myself.
The closing was delayed, as well, because the title company sent the notary to the property address in Tennessee, instead of where we live in New York. That was a big oops. Then, the next notary didn’t have the updated closing disclosure. It was a process, but it did get done in the end.
Honestly, this process was more frustrating than most mortgage experiences I’ve had (and we’ve done three purchases and one sale now). I’m sure it is just a sign of the times.
In the end, though, we now have capital ready to invest in another property and we can move on with our plan towards financial independence. If all goes to plan, we will add another $1k of passive income into our monthly budget with our next rental purchase.
So now, I’m binging the Bigger Pockets books and running numbers on deals daily to get ready to pull the trigger when we see a good buy. If anyone knows of a nice single family rental in Nashville, TN or Augusta, GA, let me know!
Stay frugal, y’all!
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