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).
-
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:
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:
You create an LLC
You buy a home
Your LLC gives you a loan for the home
You file the deed for that loan at the county
courthouse
You use the money from the LLC to buy and fix up
the property
Once the property is completed, your conventional
lender comes to refinance the loan
Your conventional lender runs title and sees
there is a loan.
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!