The Danger of Refinancing
by Vena Jones-Cox
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?
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 refinancing and doing it twice, 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.
Bio:
Vena Jones-Cox’s real estate business focuses on finding great deals on 1-3
family homes, then lease/optioning them to homeowners or wholesaling them to
investors and renovators. All told, she buys and sells about 50 properties per
year.
Vena is a frequent guest lecturer at real estate investment groups throughout
the country, and particularly enjoys working with new investors. Vena frequently
authors articles on real estate investment and the regulatory environment for
various newsletters and publications, including The Real Deal, her own monthly
newsletter. She has been a guest speaker at the Cato Institute in Washington,
D.C., lecturing on the effects of lead-based paint regulation on small
investors. And in her spare time, Vena hosts a popular weekly call-in radio
program on public radio. Real Life Real Estate Investing can be heard throughout
the Midwest and throughout the world on the Internet (WNKU.org) Wednesdays from
5:00-6:00 PM EDT.
Vena Jones-Cox is a past president of the Real Estate Investor’s Association of
Cincinnati, the Ohio Real Estate Investor’s Association, and the National Real
Estate Investor’s Association. She intends to form the International and,
eventually, Pan-Galactic Real Estate Investors Associations so she can be
president of those, too. Vena Jones-Cox has been featured in publications such
as The Cincinnati Enquirer, Smart Money Magazine, Money Magazine and Reader’s
Digest in articles about successful real estate entrepreneurs.