| | 3 Great Reasons to Avoid Over-Financing
With the introduction of 90%-100% loan to value mortgages on investment properties, many investors are taking the opportunity to refinance their properties at a higher percentage of value than ever before. Many are taking cash out at the closing for personal use, and are thinking of this borrowed money as Aprofit@.
Do yourself a favor and avoid the temptation (and the strong come-ons by some lenders) to do this.
1. When your property is over-financed, you might not be able to sell it for what you owe on it. I get calls from landlords in this position literally every day. Last week, I talked to a guy who paid $78K (full valueBhis first mistake) for a home last summer. He borrowed $76K to buy it (close to full valueBhis second mistake). Now his tenants are driving him crazy and destroying the property, and he wants to sell. He can't sell to another investor, because no educated investor will pay him what he owes for this property. He can't sell to a homeowner, because the property is too damaged. His only choices are to keep it until appreciation and mortgage pay-down bring the value of the property and the debt into line, or to spend another $10,000 restoring the property so he can sell it to a home owner for retail value.
2. When your property is over-financed, your cash flow suffers, and when your cash flow suffers, your property suffers. I got a call yesterday from the owner of a 3 family who got a second mortgage a few years back to take some cash out for personal reasons. Unfortunately, the total of the two payments plus the taxes, insurance, and other expenses are more than the total rent the tenants pay. He's been taking about $150 a month out of his pocket to own the property, and hasn't been able to keep up with the repairs. Now the city has placed work orders on the house, and he doesn't have the money to complete themBnor does he have any equity to borrow against. Two of the 3 units are vacant because of the condition of the property, and he's trying to unload it because he can't afford to make his mortgage payments. In all likelihood, he'll lose the property to foreclosure.
3. In the short AND long term, you'll pay an arm and a leg for the additional money you borrow. When you're offered a 100% cash-out refinance of an investment property, ask the lender what costs are associated with the loan. You'lll find that many mortgages like this carry costs of 5-10% of the loan amount in points and fees.
Now get out a financial calculator and check out the difference in total interest payments between a $200,000 property financed at 80% of it's value over 20 years. Then do the same calculation for the property financed at 100%, of its value. At 100% financing, you'll pay almost $40,000 in additional interest paymentsBand this is money that comes straight OFF your bottom line.
Please don't think that I'm saying that you should never pull cash out of an investment property. There are some great reasons to do exactly thatBlike to buy more investment property But keeping your total debt to less than 80% of the value of the property is the safest and most profitable way to manage your cash flow and your portfolio. Borrowing more may make you feel richer in the short term, but it's a recipe for disaster.
Reprinted from the Real Deal, a monthly newsletter for Real Life Real Estate Investors with permission of Vena Jones-Cox. Get a free 3-month trial subscription by logging onto regoddess.com.