A cash out refinance and a traditional refinance are similar loan types in which a property owner decides to use funds from a new loan to pay off an old loan in order to secure better rates and terms going forward. The cash out portion refers to when the investor is able to borrow more than what they owe on the property in order to get funds out of the deal that can then be used to improve the property or to invest into a new property.
Fundamentally the two loans are very similar, but the cash out refinance is typically set aside for the residential rental investor, whereas property investors who own substantially larger commercial properties, and do not need cash, might only do a straight refinance in order to secure better terms and rates over their existing loans.
Cash Out Refinance
When an investor wants to pull equity out of their rental property, but still have an existing loan on the property in place, they can use the Cash Out Refinance loan. They are able to secure a loan up to a set maximum loan-to-value (LTV) ratio of the property, typically a max of 70% that is based on the as-is value, and then use part of the loan to pay off the first loan, and the rest they receive as cash.
For example, if the investor owns a house that is appraised at $225,000 then the maximum loan against that house can be up to $157,500 ($225,000 (the as is value) x 70% (max LTV) = $157,500). The investor can use that $157,500 to pay off the first loan and then whatever is left goes straight to the investor. This is the cash-out portion that they can use to put towards a new property or renovate an existing property in order to increase rental income.
An investor would choose to traditionally refinance a commercial loan when they do not need to pull equity out of the property and instead are shopping for a better interest rate or the term limit is coming to a close. A similar loan structure can be setup where the investor can borrow up to 70% of the property’s as-is value and use those funds to pay off an existing loan. In this case the investor only borrows the exact amount needed to cover the original loan repayment.
For example, an investor has a $10,000,000 office building that they owe $4,000,000 on at 6%. Rates have dropped and they wish to refinance the loan at 5%. They can get a loan up to 70%, or $7,000,000, but they only need $4,000,000 to pay off the original loan and thus save 1% going forward.
Whether you are a residential rental or a commercial office building investor, the cash-out and traditional refinance loan type can very valuable way to increase your holdings or better your financial placement.
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