Real estate investors should be vigilant when considering opportunities to refinance their investments. Refinancing real estate investments can be a key part of a financial strategy under the right circumstances.
Knowing When and Why to Refinance Real Estate Investments
There are three broad, overlapping reasons why you might refinance an investment.
You may want to optimize your interest rate, extend the maturity of a current loan, or take advantage of built up equity.
The two key variables to focus on to improve the interest you pay on a loan are the interest rate trend and the loan type. When interest rates are rising and you have a variable-rate loan, it may be advantageous to switch to a fixed-rate loan. If interest rates are falling, then the greatest benefit can be gained from switching to a fixed-rate loan when they are at their lowest, whether your current loan is fixed or variable.
Figuring out when interest rates will reach their lowest point and timing your refinancing to that exact point is practically impossible. If you refinance when rates are falling, and believe they are likely to continue to fall, a variable-rate loan will enable you to take advantage of lower rates for as long as they last.
Even if your motivation to refinance is not to save money on interest, you may also benefit from refinancing your loan because it is approaching its maturity and you are facing a balloon payment. Refinancing can also be used simply to either allow for interest only payments or extend the interest only period.
If you are looking to reduce your loan payments temporarily, you might refinance with an interest-only loan, which allows you to pay interest only for a certain initial time. The payments would be comparatively low, followed either by a balloon payment of the entirety of the principal, as is often the case with hard money loans, or much higher payments of principal plus interest. This is a good strategy if you intend to sell the property at the end of the interest-only payment period, especially if the property appreciates during that time.
Finally, refinancing the loan on your real estate investment can allow you to access cash by borrowing against the equity you have accrued in your property while you maintained the original loan. When you take out a loan on a property, your equity amounts to no more than your down payment. Then, the principal you pay down is added to that sum. Keep in mind, though, that if you opt for an interest-only loan, your equity does not increase when you make interest-only payments. Again, the property may have appreciated at the same time, making even more cash available. Cash-out refinancing increases your debt load.
Refinancing Real Estate investments Comes at a Cost
These descriptions of refinancing options are deceptively simple. Besides the calculating that is needed to carry them out, fees and, most critically, prepayment penalties must be considered as well. They could offset much or all of the benefit of refinancing. It is worth keeping in mind when you finance or refinance a property that variable-rate loans have much lower prepayment penalties. Also, there is typically a penalty-free prepayment window three months before a loan matures.
Timing, costs, and conditions have to be taken into consideration to determine the refinancing strategy that best meets your investment needs. Professional advice is likely to produce the best results.
At CWS Capital Partners, we are a fully-integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We also own and manage luxury multifamily investment communities in major markets around the country, and we employ a team of experts who can help you hone your investment strategy.
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