| | 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?
A: 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 RE-financing—and doing it twice, yet—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.
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