Financing Strategies: Shorten Your Term with Cash Out

By: Craig Higdon

The Federal Reserve Board has been raising rates for two years now.  Bottom line, this activity has meant higher rates for the investor.  It follows a period in which America experienced the lowest rates in several decades. Therefore, it's no wonder that many investors purchased or refinanced their properties in the past five years.

The result of these low rates and other demographic factors?  We experienced a real estate boom not seen in the history of our country.  Many purchased properties while prices were rising and even though rates were at historic lows, they chose adjustable rate mortgages in order to increase cash flow when they purchased or refinanced.  And as the Federal Reserve has raised rates, the rate on their adjustables have also risen and increased their payments.  To exacerbate this situation, real estate taxes and insurance rates are also going up as the values of properties rise, putting pressure on cash flow.  Together, your "payment" can rise as much as $2,500 per month per $1,000,000 in mortgage amount.  If an investor “reached" to purchase a property, this increase can wreak havoc on the P&L.

However, there is good news on two fronts.  First, although the Federal Reserve has raised short-term interest rates, long-term rates are still historically low.  In fact, fixed rates are very close to the start rate of many adjustables for the first time in decades.  This means that 10-year fixed rates are still a bargain.  It makes sense that someone who has experienced an increase in the rate of their adjustable would chose to move into a fixed rate mortgage.

For example, if your adjustable has moved to 6.5% and the rate for fixed rate mortgages is 6.5%, your refinance into a fixed rate will lock in this rate and protect you from future adjustments.  Note that these rates are for comparison purposes only and you should call me for an actual quote.

The second part of the good news?  With property values rising, the refinance can include cash out to help you with these higher payments, pay off other debts, or even shorten the term of your mortgage!

For example, if your payment increases by $2,500 each month and you lock in a fixed rate, an acquisition of $125,0000 in cash can help you “afford" these payments for up to four years.  Or, if you have credit card and other debts of $125,000 and your payment on this debt is $3,750 each month, the refinance can actually lower your total payments by $1,250 monthly even taking into consideration the fact that your mortgage payment went up with your adjustable rate increase.

How would you actually shorten the life of your mortgage?  Let’s say you can pay the higher mortgage payment after the adjustable goes up, that you are over 40 years old, and would like to retire with no mortgage sometime in the future.  You could refinance into a 20-year mortgage.  This would increase the payments by approximately $1,135 each month on a $1MM mortgage.  Now the $125,000 you obtain in cash can make the payment for approximately one-half of the 20-year mortgage term. In other words, you can be halfway to paying off your mortgage in 10 years!

The Federal Reserve increasing interest rates is bad news for the investor in the short-run.  In the long-run, your ownership of real estate gives you plenty of options to deal with the present and the future.

Money Management
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