Real Estate – Refinancing My Rental Property

03-29-13 Real Estate - Refinancing My Rental Property

Real estate as an investment has been a hot topic for debate after the bubble and corresponding crash from a few years ago.  While I can understand the uncertainty and fear that comes with real estate after so much turmoil, I believe real estate is a vital piece of long-term wealth development. A rental property when properly leveraged can be a strong hedge against inflation. Additionally, a rental property that produces positive cash flow can be a viable addition to a passive income portfolio.

As I posted back in February, I have an unintentional rental property. This townhouse (not pictured, but very similar) represents my biggest financial mistake thus far. Since moving and being forced into a rental situation, this house has been a tremendous cash flow drain on my finances. Originally purchased with five percent down, there was no margin for error when the housing bubble burst in 2008. At its lowest point, the house was approximately $50,000 underwater.

Dealing With An Underwater Rental Property

Having a complete lack of equity in the house eliminated refinancing as an option to reduce the negative cash flow on the property. Complicating things further, because the house transitioned from a personal residence to a rental property, it was deemed an investment for lending purposes. When the various financial assistance programs were rolled out by the government such as Home Affordable Refinance Program (HARP) my townhouse was ineligible and did not qualify to be refinanced as an underwater rental property.

Without any options to refinance, I had pretty much given up hope of dropping the 5.875% interest rate on the original mortgage. As interest rates continued fall it was frustrating to be unable to improve the loan situation. Ticking down from around 6% when I bought the house, mortgage rates have gone from an average of 6.03% in 2008 to 3.66% in 2012 (Source: Freddie Mac).

Hello, Refinance!

In February, the day after I first posted about my unintentional rental property, I received a call from Wells Fargo regarding the status of my mortgage. Due to a change in the rules of HARP, although my house was a rental property, it was now eligible for a no-cost, no-appraisal refinance. Have you ever won the lottery? I haven’t, so I can’t compare the feelings, but it felt like a pretty big win in my book!

Since getting the call from the bank, the entire refinance has been arguably the most pain-free loan process as I’ve ever been involved with and took less than 45 days to close. Part of the ease of the process was it was a HARP refinance which greatly reduced the requirements. Those reduced requirements included an estimated value of the home provided by the bank, a verification of income and employment, a year’s worth of bank statements, and a few simple explanations. After that, the loan was off to underwriting.

New Financials For The Rental Property

I locked in a 4.125% interest rate for a 30-year, fixed-rate mortgage. As a rental property, the new rate suffers from a half-point penalty over market rates. Bottom line, after a little over five years since purchase, I was able to knock 1.75% off the original interest rate. With net closing costs of $2,104.21, my payoff period will be less than six months.

After all said and done, the refinance adjusted the overall financial picture on my rental property tremendously. Below is an updated financial summary of the house.

Townhouse Rental Financials

 
 
Income
Totals
Monthly Rent Income
$1,375.00
Less: Management Fees
$(137.50)
Net Rental Income
$1,237.50
Expenses
Mortgage (P&I)
$1,049.63
Escrow (Taxes, Insurance, and PMI)
$305.64
Homeowner's Association
$120.00
Repairs/Maintenance Allowance
$100.00
Total Expenses
$1,575.27
Net Income (Deficit)
$(337.77)

So what does this do for me? By refinancing the mortgage on the rental property, I was able to increase my month cash flow by $355.45, saving me $4,265.40 per year. While the financials above show a net loss of $337.77 per month, $100 of this is repairs allowance, which is not realized until expenses actually occur. The rental property is performing just above the break-even point when netting the actual cash flow loss with the new principal repayment amount, which is in excess of $300 per month. None of these numbers factor in the tax benefits of owning a rental property.

Even with the overall decrease in negative monthly cash flow, my current plan is to still get rid of this property. With the rental located a few hours away, I have to rely on a management company to find my tenants, handle the smaller repairs, and assist with any other challenges. While this is convenient, it costs extra money. Lastly, I would like to be more involved and would prefer to invest in a property closer to my current location.

The financial benefits from refinancing put me into a situation where I can afford to wait until the property will sell for break-even or better. I do not intend on a selling the property for a price where I would have to bring cash to the table to close.

Prior to refinancing, make sure you have a good grasp of your credit score. Having good credit is a top priority for me, and as a result I use Credit Karma to monitor my credit for free. No monthly commitment, no credit card charges, no cancellation madness. Just monthly credit score updates for free. Stay on top of your credit like I do with Credit Karma.

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Comments

  1. Glad you were able to get this refinanced. The cash flow’s still negative but I’m sure it’s much better than before. I’d like to get a rental property, but I’m in the same boat as you as with not wanting to pay the management fees. I’d be forced to do that right now.

    • Between the management fees and my ability to find better cash flowing properties near me, it is a no brainer to drop this house as soon as it becomes financially feasible!

      Thanks for stopping by JC!

  2. That’s awesome you were able to go through with the Refi! We would love to be able to, but with running our own business the whole lack of W-2 income makes that next to impossible.

    • Stoked doesn’t even begin to describe the awesomeness! The refinance essentially gave me a $6,000 dollar raise before taxes and makes holding this unfortunate rental a bit easier.

  3. I am all too familiar with this situation. You and me were living the same story my friend. As for me I was able to sell my property at a loss but I was happy to get rid of the monthly net loss. Glad to hear you were able to refinance, maybe if I held on a little longer I would have received a phone call as well. This would have completely changed my situation and I may have been able to hold onto the property.

    • Thanks for stopping by Marvin! It would be interesting to see where your house has gone in value since you sold it and how that might have changed or not changed your decision, as well as what the overall change in monthly cash flow would have been given a similar rate drop.

  4. Larissa says:

    I’m very glad you were able to refinance.
    My husband and I are in a situation similar to what yours was. We have an unintentional rental property, which is a little underwater.
    We have never missed a payment and both have excellent credit. However, we haven’t been able to refi because our loan is not backed by Freddie Mac or Fannie Mae. I’m wondering if yours was (?). If it wasn’t I would love to have a way to contact the people from Wells Fargo that helped you out.
    Thank you for sharing your experience.

    • Thanks for stopping by Larissa! Yes, my loan was backed by Fannie Mae thus enabling me to refinance. Unfortunately, HARP rules only allow those with the backing of Fannie or Freddie to refinance at this time as you have found out.

      • Larissa says:

        Thanks for getting back to me. Hopefully the rules will change again in the near future allowing us to refi..

  5. Wow, I’m in the same boat, I’m hearing I need 75% equity (talked to a lender today) in order to refi my accidental landlord property.
    I’m going to contact my bank directly (Chase) and see what they can do. I was fairly discouraged until I read this post.

  6. I own 12 rental homes! I need to refi one. Who can I find that will refi my rental if I’m over the max of 10

    • You are probably going to have to do something outside of traditional banks. I’d recommend you head over to the to see what ideas people there have. Bigger Pockets has a great number of knowledgeable and experienced investors who might be able to help you with ideas specific to your situation.

  7. had to weigh in on my experience w/ Wells Fargo: I too was contacted by them in February 2013 (completely unsolicited on my part) re HARP program. Reducing my rate & minimal costs to refinance was a no brainier. Unfortunately, it was the most disjointed, unprofessional experience one could imagine. Finally closed SIX months, that’s right, six months later. Repeated requests for same documents, multiple requests for additional documentation “from underwriting”, weeks went by without contact or returned calls, etc., etc. Only thing kept me going, not to mention the time already invested, was the carrot they held, e.g., lower interest rate/lower monthly payment. Finally closed, new mortgage, new rate, new payment but wouldn’t cross the street to do business with Wells Fargo again. (note: I’m a 30+ year real estate broker, investor, landlord…wasn’t my first rodeo)

    • Davis, sorry to hear you had such a poor experience. As I said in the post, mine was extremely hands off and professional done. It was very unobtrusive, timely, and every effort was made to work with my schedule and the additional considerations of removing my ex-wife from the title of the property. Thanks for stopping by!

  8. Do any one have experience to refinance with Quicken Loans – investment properties?

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