Homeowners Use This Surprising Method to Buy Homes – Should You?
Once people realize that they can use their home to make money and not by renting out rooms, they get interested. And most who own a home they bought before 2020 have seen it increase in value, as homes across the country have seen double-digit price growth year over year since 2019 or before the pandemic. So what is the surprising method? A cash-out refinance.
What is a Cash Out Refinance?
A payout refinance is a method of using the equity in your home for any purpose you desire. You take out a new mortgage loan for more than what you owe. The surplus is your cash, which you can use to buy another property or make a down payment. Other popular uses of a cash out refinance include debt consolidation, home renovations, and home repairs. Although you can use the money for a vacation or something reckless, most financial advisors advise against it — if times hit you hard and you can’t afford the mortgage payment, you could lose your home.
I have used this method successfully
I bought my last rental property through a cash payout refinance. It was the summer of 2020 when house prices started to rise and mortgage rates were at an all-time low at around 2.5% for a 15-year mortgage. I would definitely refinance at that rate, and it happened to be the perfect time to take some money out of the house to buy another property.
You might want to consider this
If you own a home and have a significant amount of equity — 20% or more — you may also want to do a payout refinance. Mortgage rates are still low, so you probably won’t be paying a higher rate. You can even lower your interest rate.
Be aware of the risks and disadvantages
There are some risks and downsides to cash out refinancing that you should generally be aware of.
- They are expensive and typically range from 2% to 5% of the new loan amount.
- You start your mortgage from scratch. However, you can change the terms to a 15-year mortgage if you don’t want to commit to another 30-year mortgage.
- Houses can depreciate. (Though as of this writing, March 2022, there are no significant price declines on the horizon.) If your home goes down in value, you could end up owing more than the home is worth.
- You could lose your home if you can no longer make the new loan payments, perhaps because of a job loss or some other catastrophic situation.
There’s another major risk of using the cash-out refinancing method to purchase rental properties — putting yourself in too much debt. This could easily happen when you start closing a lot of deals at once, withdrawing equity from one property to buy another each time. If you don’t have enough cash flow/income to keep up with some sort of house juggling, the whole thing can collapse, potentially leaving you with nothing.
Being over-indebted to this extent can happen when you lose a source of income that you count on, such as a loan. B. Your job. But it could also happen that vacancies exist or are rented out to tenants who no longer pay rent (eviction can be a slow and expensive process).
Leveraging your money works best when you don’t spread yourself too thinly. It helps to keep significant cash reserves in a bank account, e.g. B. Six months’ expenses for each property. This could get you through a tough time so you aren’t forced to sell at an inconvenient time.
Get the money first
At a time when many people are doing cash-out refinance, like now, it is better to complete the loan transaction before looking for real estate to buy. I made the mistake of finding a property first and then starting the process, thinking it shouldn’t take longer than a maximum of 45 days (and probably not even that long) to get my money. I was wrong. In my case, it took almost three months to complete the loan. I was able to save the deal by borrowing money from other sources as a bridging loan. But the process was stressful, to say the least.
How to qualify
To qualify for a payout refinance deal with most mortgage lenders, you must meet the following conditions:
- You must retain 20% of the equity in your home, meaning the maximum you can take out of the home is 80% of the equity.
- Most lenders require a minimum credit score of 620.
- You need a source of steady income.
- Your leverage ratio (DTI) must be below 43%.
If you qualify, a cash-out refinance could be the way to fund your next real estate deal.