The Danger of Refinancing
|Q: I am a new investor (I bought my first rental 18 months ago and now have 5 houses) and I am having a “cash crunch” due to some vacancies and some rehabs I need to do. Is it smart for me to refinance some of my houses with interest-only loans to reduce my payments, then refinance again in a year or so to get the payoffs back on track?|
I have major concerns about this plan, especially for you as a “new investor.” There’s nothing wrong with interest-only mortgages; in fact, I’ve gotten a few of these myself, when the numbers made sense and the lender was willing. The problem with refinancing and doing it twice, is the expense involved. A typical refinance with a mortgage broker (and I assume you plan to use a broker, since “traditional” lenders usually don’t tend to offer this kind of product) costs $2,000-$4,000 in closing costs, application fees, points to the broker, and so on. These costs are not recoverable by you in terms of a higher property value or increased rents, the way money spent upgrading the property would be. They are pure expense and lower the overall return on and profit from your deal.
What you are proposing is to refinance not once but twice in the upcoming year, meaning that you could be looking at up to $8,000 in additional expense for the privilege of making lower payments for awhile—maybe. When you begin to look at the rates charged by lenders for interest-only loans, you’ll find that they are sometimes higher than for loans that will eventually amortize themselves. I’ve recently seen rates on interest-only loans as high as 13%, which makes no sense for you if your goal is to have higher cash flow. If you do the math, you may find that the interest-only loans you’re being offered actually have higher payments than your existing, fully amortized loan!
But the thing that concerns me most about your question is that, in my experience, continually refinancing properties to pull cash out or to improve the terms of a loan is a big mistake. In fact, when I see investors go belly-up, it’s always because of one of 2 things: overspending on renovations or over-financing their properties to the point where there’s no equity (or cash flow) in the property. In fact, over-financing isn’t just a problem for beginners–it’s has been responsible for the downfall of many experienced investors, as well.
My suggestion? Either sell one or more of your non-performing properties, or—better yet—wholesale a few deals for a $4,000-$7,000 profit to meet your immediate cash needs. And in the future, try to keep some of those rents in reserve for occasions like this: they will occur again and again, and the best way to weather them is to be prepared for that fact.
|Vena Jones-Cox is a past president of the Real Estate Investor’s Association of Cincinnati, the Ohio Real Estate Investor’s Association, and the National Real Estate Investor’s Association. Vena has been featured in publications such as The Cincinnati Enquirer, Smart Money Magazine, Money Magazine and Reader’s Digest in articles about successful real estate entrepreneurs.|
Vena Jones-Cox’s real estate business focuses on finding great deals on 1-3 family homes, and then lease/optioning them to homeowners or wholesaling them to investors and renovators. All told, she buys and sells about 50 properties per year.
Vena is a frequent guest lecturer at real estate investment groups throughout the country, and particularly enjoys working with new investors. Vena frequently authors articles on real estate investment and the regulatory environment for various newsletters and publications, including her own monthly newsletter. She has been a guest speaker at the Cato Institute in Washington, D.C., lecturing on the effects of lead-based paint regulation on small investors. And in her spare time, Vena Jones-Cox hosts a popular weekly call-in radio program on public radio.
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