This is the second part of a two part article. If you haven’t read the first part yet, check out “How to cashflow over $1000 in 2019”.
It still baffles me to this day that we can create money out of thin air. The bank is doing this everyday by printing out more money and lending out new mortgages. How can we take advantage of the money system and also get in the game of money creation?
Refinancing is when you obtain a new mortgage and pay off your existing one. Why would someone want to do this? After all, there are legal fees, appraisal fees, and mortgage penalties involved. The two main reasons are to get a more favourable rate and to access equity in your property.
The first reason is pretty self-explanatory. A lower interest rate will pay huge dividends over the long term because you pay more towards your principal every month and your monthly mortgage expenses are also lower. For example, I replaced one of my mortgages of 3.84% with a 5-year fixed at 2.94%. At this lower rate, over $1,000 extra goes towards paying down my principal every year. My monthly mortgage payments are also $204 less, which means I have more cash flow going into my pocket. The total savings over 5 years is $17,933 and I would recoup my penalty in under two years. In this case, my penalty was $4,000 (tax deductible) so it was a no brainer to lock in the lower rate. It’s all a math exercise to see if this maneuver is worth it and how long it would take to recoup your penalty costs.
The second and arguably more important of the two reasons is to access the equity in your property. This equity is usually due to a combination of all three: appreciation, mortgage paydown, and forced appreciation. The heart of our strategy is BRRRR (http://bjgcapital.com/how-to-scale-your-real-estate-portfolio-quickly-with-brrrr/). By improving the property and changing its use from a single-family home to a multi-unit duplex, there is forced appreciation. Forced appreciation is literally creating money out of thin air.
Refer to “How to Cashflow over $1000”. We refinanced this property after it was converted to a duplex. To summarize, we paid $458,000 in May 2019. Renovations were $40,000. Two months later when renovations were completed, the property was reappraised at $550,000. At an 80% LTV, we pulled out $75,000 out of the property after paying off the old mortgage. This was a win on several levels:
1. First, the equity we pull out is TAX FREE, not to mention the interest is also tax deductible!
2. Second, we bought the house at $458,000. We put in $40,000 in renovation costs which comes up to $498,000. Now the house is worth an extra $52,000 after two months! In other words, every dollar we spend on renovations yields a higher value on the house. This is called sweat equity and we were rewarded for improving the property.
3. Third, by taking equity out, we can roll this capital into other investments.
4. Finally, it boosts our return on investment (ROI), now that we have less money in the deal.
UPDATE after REFI
Purchase Price: $458,000
Market Value: $550,000 (appraised in August and has since appreciated)
80% LTV @ 2.74%; 4 year fixed, 30 year am
Money Invested in the Deal: $65,581.19 ($140,581.19 – $75,000)
Monthly Rental Income
Upper: $1,675 + 60% utilities
Lower: $1,425 + 40% utilities
Property Management: $180.79
Property Tax: $275.66
Maintenance Cost: $200
Cash Flow: $537.84
Yearly Principal Paydown $9,591 +
Yearly Cashflow: $6,454.08
Yearly Appreciation: $16,500 + (conservatively at 3%; in 2019, Barrie SFH detached appreciated approximately 7%)
Even though our cashflow is less after the refinance, it’s still a healthy buffer for any downturns in the real estate cycle. Remember, real estate wealth is not created primarily by cashflow. It is mainly from mortgage principal paydown and appreciation. Because we have less money invested into the deal, we are dividing our yearly returns by the capital we still have in the deal ($65,581.19) which yields a higher ROI!
The ultimate goal is to pull all our money out of the deal while still having an LTV of 80%. That way we are not OVERLEVERAGED. This will truly be infinite returns since we have $0 invested into the property and the rental property will be an annuity that pays you every month for the rest of your life!
The longer you wait, the faster the wealth gap will widen. Are you in the game yet?