Rental House - Refinance to maximize cash flow?

[Taran Wanderer]

I really dislike debt, so I have been mulling over options with our rental property.  It's not an ideal rental because of a big yard with a fair amount of work to take care of it, but it is very close to our house, and it's the right size and location to rent quickly.  The rental rate keeps the riffraff out, but it's not so high that it stays empty, so it stays rented and makes a little money.  If we were to sell it and buckle down on our home loan, we could be debt free in 3 to 4 years, and then we'd be FI.  But, long term, keeping the rental is a better financial decision.  With the advantage of leverage, our return on equity is higher than we could expect from average stock market returns.

So, if we're going to keep it, I'm wondering about the refinancing to maximize cash flow.  We may be able to drop our interest rate, reset the thirty year clock, and drop our monthly payment by $200 or so.  That with a rent increase to match the market would take us from cash flow neutral (still making money because of the principal each month + the tax break at year-end) to cash flow positive in the range of $400 a month.  And, assuming rents continue to rise in the future, that number gets bigger.

Has anyone else thought through this?  What was your conclusion?

Another question... With a rental, are we better off keeping the mortgage as high as possible relative to the property's value, even if that means refinancing periodically?  (Assuming interest rates stay low, of course...)  Through refinancing, we could extract equity to purchase additional rental properties, right?

I'd appreciate the forum's thoughts.  Thanks!

[arebelspy]

It depends on both your goals, thoughts around leverage, and the actual numbers.  Refinancing costs money.

Read the thread on how long paying off your mortgage sets back FIRE for the debate on paying off a mortgage versus keeping it, as it's directly relevant to the refi question.

Good luck!

[waltworks]

Impossible to answer with no numbers. Read the sell or rent sticky in the RE forum.

-W

[Lmoot]

I would do it only to get a lower interest rate. I wouldn't refi for another 30 years since that would likely obliterate interest savings (UNLESS you plan on using the extra cash for additional leveraging, like buying another rental property). Cashflow only matters if you plan on investing and/or leveraging the extra cash (and expect to gain more than what the refi/extended loan would cost), or if you simply need the extra cash.

Increased cash flow via the method you are describing often times just gives the fuzzy feel-good illusion of more money, but you could end up paying more. In my case I have to refi my 1 rental property for a lower rate AND another 30 years in order to decrease my DTI ratio as much as possible, so that I am more likely to be approved for a loan for another property in the short term. I could pay my house off in 1 yr 1/2, but would rather put that money into the DP of another property as I find that I've been doing better on my one property than all of my investments combined (which granted, so far is not that much).

[Taran Wanderer]

Purchased the rental as a primary residence for $144K in 2004 with 10% down.  Payed a lump some a year later to drop PMI.  Refinanced in 2007 during the bubble and pulled out $82K in equity which we used to build our current home.

--- Yes, pre MMM thinking and given subsequent market activity in 2008/2009, could have / should have turned this $82K into $182K in the market or $882K with some targeted real estate investments, but so much for 20/20 hindsight. ---

Refinanced again in 2011 along with a drop in interest rate on Chase's nickel for one of a couple of reasons:
1)  Chase suspected we would pay to refinance to get an even lower interest rate and they would lose us, or
2)  Chase needed to consolidate their rights to the property after acquiring the loan with less than solid paperwork in the heated 2007 bubble.

Fast forward to 2016 and we currently owe $163K with a 4.65% rate and a current market value of about $250K.  Monthly payment is $1,093 ($295 P, $632 I, $165 T+I).  Refinancing can probably be done for $4K and will drop the interest rate to 4% over 30 years.  Wrapping the refi cost into the new loan would increase the balance to $167K, drop P+I from $927 to $795 and put an extra $130 into our pockets each month.  Coupled with a $100 rent increase, we could further up the cash flow to $230/month.  Future rent increases could further improve this.

This money could go one of several directions -- kids' 529 accounts, money toward down payment on another rental, or taxable accounts.  We are already maxing out our tax advantaged accounts.

Thoughts?

[Lmoot]

Wow, I would calculate how much you've already voluntarily spent on that original loan of $130,000 (between the 1st refi, paying a lump sum to drop PMI (did you have to refi to do this?), only to turn right back around and borrow back the equity (more closing costs....essentially paying to borrow back the money you didn't need to pay down in the first place), which put the PMI right back on, probably at higher than it was before you initially dropped it). And now you're talking about another refi to save 0.65% AND you want to pay interest on the closing costs by rolling it into the loan for that refi; is the 4% the interest rate or the APR? Because if you roll in closing costs that will make your APR go up. Most Refi wisdom advises refinancing is not worth it for less than a 1-2% difference in interest rate.

Honestly, you probably would have done better to just do the initial refi to reduce interest rate, save towards a DP to build your house, and taken on a separate mortgage for the building of the house. You have paid much more adjusting that loan than you should have, with all that schizo back and forth. Try to visualize beyond a couple of years and commit to a goal....and stop using your mortgage as a deposit/withdrawal account.

All I can say is you are mortgage lenders' dream customer. No wonder Chase wanted to keep you at all costs! LOL.

Also, I don't intend to be mean. I've heard that's how it's done around here (tough love?)....and I'm just trying to fit in so I can be friends with the popular kids.

[frugaliknowit]

Before proceeding, you need to calculate:

1.  Your TRUE "cash on cash" return (return each year after taxes based on how much you have sunk into the place).
2.  Your TRUE overall return at current market (cash return +/- equity return).

Is this property making sense?  If it is, then evaluate whether the refi makes sense.

Based on this alone:  "...Coupled with a $100 rent increase, we could further up the cash flow to $230/month" and "shooting from the hip", I'd say your cash on cash is "zippo to negative", even after the refi (assuming some vacancy allowance).  Sounds like you should dump this property and invest elsewhere (too much leverage, not enough rent, and too much land).

[Taran Wanderer]

Before proceeding, you need to calculate:

1.  Your TRUE "cash on cash" return (return each year after taxes based on how much you have sunk into the place).
2.  Your TRUE overall return at current market (cash return +/- equity return).

Is this property making sense?  If it is, then evaluate whether the refi makes sense.

Based on this alone:  "...Coupled with a $100 rent increase, we could further up the cash flow to $230/month" and "shooting from the hip", I'd say your cash on cash is "zippo to negative", even after the refi (assuming some vacancy allowance).  Sounds like you should dump this property and invest elsewhere (too much leverage, not enough rent, and too much land).

I can do the math.  Bottom line is that either way, the place just doesn't generate much free cash flow for the amount of equity tied up in it.  Then there is the issue of future maintenance, the potential for earthquake or flood damage (which if insured against would wipe out the free cash flow).  Sure, when the principle payment each month is factored into the "return", it works from an ROI and ROE standpoint, but that principle isn't accessible until a date far in the future.  And if the house is damaged by an uninsured natural disaster, the equity is gone.

As for the two comments about refinancing, remember a couple of things:
1.  Falling interest rates.
2.  Paid to refinance one time which dropped the interest rate significantly, spun off significant equity to fund our current home, and kept the payment the same (yes... it extended the term).
3.  Pre-mustachian thinking...

One thing that is funny about this forum is that the attitude on real estate debt seems to be schizophrenic:
A.  Don't pay it off early because you can get a better return elsewhere!
B.  Don't refinance to extract equity to apply elsewhere because financing costs are bad!

C'mon, really, which is it?

[Taran Wanderer]

Sounds like you should dump this property and invest elsewhere (too much leverage, not enough rent, and too much land).

This is actually the right answer.  Just need to convince DW.

[Lmoot]

One thing that is funny about this forum is that the attitude on real estate debt seems to be schizophrenic:
A.  Don't pay it off early because you can get a better return elsewhere!
B.  Don't refinance to extract equity to apply elsewhere because financing costs are bad!

C'mon, really, which is it?

Well the "elsewhere" you applied the equity to was more real estate (and not even another investment property), so you failed A & B in that one move. And especially failed "A" big time by paying down early, then cannibalizing your early paydown by turning around almost immediately and borrowing it back (and paying for the "privilege" to do so). Hey, we all make mistakes, but you're still making them IMO if you are even considering another refi, just to save a measely 0.65%

If holding rental property wasn't a strategic move on your part, or you no longer want to deal with it, then I agree the property should be sold.

[arebelspy]

One thing that is funny about this forum is that the attitude on real estate debt seems to be schizophrenic:
A.  Don't pay it off early because you can get a better return elsewhere!
B.  Don't refinance to extract equity to apply elsewhere because financing costs are bad!

C'mon, really, which is it?

Which is it?  Well, it depends on the situation.  Read the first reply in this thread:

It depends on both your goals, thoughts around leverage, and the actual numbers.  Refinancing costs money.

For some people, refining cash out is a great idea.  For others, not.  It depends on the numbers first, and then if that works, on the investor and their goals and temperament.

Also, as I said:

Read the thread on how long paying off your mortgage sets back FIRE for the debate on paying off a mortgage versus keeping it, as it's directly relevant to the refi question.

You seem to try to point out that the issues are linked as a "GOTCHA!  Which is it?" when clearly understand the issues go hand in hand, and reading arguments for the one (pay off early) are "directly relevant" to the other (cash out refi).