DFW REI Club

 Dallas/Fort Worth Real Estate Investor Club

THE "CASH OUT CONUNDRUM"

  • 08 Jun 2017 2:41 PM
    Message # 4888103

    The “Cash Out Conundrum”

     The title sounds like a Murder/Mystery novel and while it’s not that serious receiving a cash out loan on an investment property can be a very confusing item.  This post is designed to bring some clarity to taking cash out of a property with a conventional loan and help you navigate the sometimes-challenging cash out rules for properties. Admittedly, this post will probably be for the mid-level to expert level investor. There could be some important items in here if you are just starting out but it might get confusing in a hurry.  If you have any questions, then please reach out.  Lots of people on this forum can answer questions and many are very helpful individuals.

     We will cover:

    1.       The conventional rules for a cash out loan

    2.       Buying a home with cash

    3.       How to properly structure buying a property with cash

     

     

    1.       The Conventional rules for Cash Out Loans

    Fannie Mae and Freddie Mac are the Government Agencies that sponsor conventional lending.  Most banks will have these loans as an option.  There are other loan types as well but for brevity we will limit this post to the “Conventional” lending (Fannie/Freddie).

    • Conventional Loans limit your cash out on an investment property to 75% of the “After Repair Value” on a Single-Family home (70% on a 2-4 unit home).  This is also the same percentage that you need for a non-cash out refinance (more on why that is important later).

    • If you purchased the investment property with a loan, then conventional loans will require you to wait 6 month to take cash out.

                                         This rule does not apply if you purchased the home with CASH (more on that in section 2).

    Let’s explore some examples here:

    • If you purchased a property with a 15% down conventional loan (85% loan to value) and you wanted to get cash out, you wouldn’t be able to do so since the cash out limit is 75% of the “Loan to Value”.  The MAXIMUM cash out you can receive is 75% of the value of the property.

     

    • If you purchased a property with a loan, but did the rehab on with your own cash, then you would need to wait 6 months to get that cash back.  Keep in mind you could only receive 75% back of the After Repair Value. 

      • So if you bought a home with a loan of $50k, it required $30k in renovations, and it appraised for $100k after the repair work was complete then….
        • You would refinance the $50k loan, receive back $25k in cash…since $75k would be 75% of the After Repair Value.

     

    2.       Buying a home with Cash

    Buying a home with cash has become increasingly popular for many investors but often an investor will be caught with the restrictions to cash out loans if they need to get their money back.  There is a plan to avoid this entire section (In section 3) but it is important for us to know about these restrictions.  If an investor is buying with cash and flipping they get their money back when they sell the property.  But if they are seeking to hold a property for any length of time and want their cash investment back there are some important rules to understand with conventional loan:

    • If you buy a property with cash (or with a HELOC) you can receive a cash out loan on Day 1.
      • There is not a 6 month waiting period with receiving a cash out loan if you purchased a home with cash or with a HELOC
      • BUT you will be limited to the amount of….
        • Your purchase price + closing costs (costs when you purchased the home).....OR....
        • 75% of the “After Repair Value”…

                                            WHICHEVER IS THE LOWER AMOUNT (super important)

                                    These rules are important to understand so here are two examples:

    • Example 1:  If you purchased a home with $50k of cash, and put $30k of renovations into the loan, and the home was worth $100k.  75% is $75k and $50k is your purchase price.  So you could only receive $50k in your first 6 months of ownership since the LOWER amount is your purchase price.  After 6 months you could receive the full 75% of the ARV.

     

    • Example 2:  If you purchased a home with $80k of cash, put $5k into the home, and the home was worth $100k.  75% would be $75k and your purchase price is $80k…so the lower amount is $75k.

    When buying a home with cash you can absolutely get cash back right away but you will be limited to the lower of those two amounts.

    3.       HOW TO PROPERLY STRUCTURE BUYING A HOME WITH CASH

    With these rules, you can see how it can be confusing to get conventional lending when buying a home with cash but there is absolutely a proper method to structuring your deals when buying cash.  Here’s the secret:

     

                        Create an LLC and have the LLC lend you a mortgage on the property you are receiving.

     

     The reason why this works is because instead of you needing cash or receiving a cash out loan, we are now refinancing a loan – your loan.  There no reason to wait any time or have any “whichever is lower” rule come into play.  We are just refinancing a loan.

     Here’s how it works: 

    1. You create an LLC
    2. You buy a home
    3. Your LLC gives you a loan for the home
    4. You file the deed for that loan at the county courthouse
    5. You use the money from the LLC to buy and fix up the property
    6. Once the property is completed, your conventional lender comes to refinance the loan
    7. Your conventional lender runs title and sees there is a loan.
    8. Your conventional lender refinances you into a new loan, and cuts a check to your LLC…a check in the amount of 75% of the value. 

    Please don’t confuse this 75% with a “cash out” amount.  The non-cash out LTV on a refinance is also 75%.  We are refinancing a mortgage.  Your LLC’s mortgage.  Essentially your LLC has become the bank/hard money lender/etc.  You get to set the interest rate (it can be 0%) and you get your cash investment amount back sooner.

     Some things to think of:

    • To file a deed at the county courthouse is $100-$150 in cost (depending on which county)
    • And you want that note to be pretty close to 70% of the ARV for the property if you don’t want to bring any money to closing.  70% will allow you to roll in your closing costs.  If you want it to be at 75% just keep in mind you would need to bring your closing costs out of your pocket to complete the refinance. 

     This was a lot of information.  Feel free to ask additional questions if you need.  Thanks!

    Last modified: 08 Jun 2017 2:44 PM | Andrew Postell
  • 08 Jun 2017 10:21 PM
    Reply # 4888589 on 4888103

    very good article

  • 09 Jun 2017 7:08 AM
    Reply # 4889444 on 4888103

    Thanks Andrew.  Great information!

  • 09 Jun 2017 4:22 PM
    Reply # 4890280 on 4888103

    Great article.  I just want to emphasize the rules stated in the article are only for Fannie/Freddie financing.  There are other options for financing beyond Fannie and Freddie that have different rules which may be useful for investors to consider.

    Thank you,
      Neil Aggarwal
      NSA Partners, Ltd.

  • 11 Jun 2017 4:00 PM
    Reply # 4892011 on 4888103

    Good article Andrew.  I'm currently buying properties cash and have never thought to use 3 mentioned above.  How does this save you money?  Bank still needs to close refi at a title company and run/pay for all title/attorney fees even if your company has loan on property.  My local lender will lend me on rentals the day after I close as long as there is clear title.  

  • 12 Jun 2017 8:51 AM
    Reply # 4892732 on 4892011
    Rocky Vasquez wrote:

    How does this save you money?

    You are correct, you have to pay fees at every closing so this may not save you money.
    The idea is that you can get money out of the property to use to get more properties.
    This is for gaining leverage.

    Thanks,
      Neil Aggarwal
      NSA Partners, Ltd.


  • 12 Jun 2017 4:37 PM
    Reply # 4897344 on 4892011
    Rocky Vasquez wrote:

    Good article Andrew.  I'm currently buying properties cash and have never thought to use 3 mentioned above.  How does this save you money?  Bank still needs to close refi at a title company and run/pay for all title/attorney fees even if your company has loan on property.  My local lender will lend me on rentals the day after I close as long as there is clear title.  


    Rocky, yes, you can get several different types of loans that give cash out loans on Day 1.  And the strategy above isn't about "saving" money but about receiving more cash out from 'conventional' lending.  Conventional loans will write a cash out loan on day 1 too if you buy with cash.  But #2 above about "buying a home with cash" would come into play.  Other loan types that I might call "portfolio" lending may not have those same underwriting rules. Some banks may refer to it as their "commercial" loan.  In either case, this may not be applicable for your specific scenario.  The rules above are for "conventional" loans.  The loan types for people looking to finance 1-10 properties with a loan.  As I mentioned above, for the sake of time I wanted to limit this to conventional lending.  That article was long enough just on that subject!  But the 3rd area of focus is a strategy that helps you get more money out of your property it certain situations.  It's not for every home/scenario but it is a good strategy if you are financing your first 10 properties (or so) and if you buy with cash and if you are not flipping and if etc. etc. etc.  Again, it's not a strategy for everyone or one that occurs often but if you are seeking the terms of conventional lending, and buying with cash, and buying at less than 75% ARV, and are needing to get the cash back out within the first 6 months....then it is a very good strategy and one that not a lot of cash buyers are aware of using.  Feel free to ask more questions if you need.  Thanks!
    Last modified: 12 Jun 2017 4:38 PM | Andrew Postell
  • 18 Jun 2017 7:24 PM
    Reply # 4906531 on 4888103

    Good article Andrew, it covers a lot of what we were discussing at the REI meeting a couple Saturday's ago. I think there is truly an education gap that exists for investors on how to properly leverage for success. There is plenty of discussion about funding sources, Private Money, Hard Money, Conventional Loans, and How to Find Funds for Your Next Deal, etc., but little to no time is spent educating investors of how to properly acquire properties to maximize their leveraging opportunity. 

    Thanks for taking the time and initiative to bring these points to light. 


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