Before you set out on the journey of completing a BRRRR deal, you should work on finding a lender who understands investment property loans. We found that there were a lot of people who thought they understood these loans but very few who actually did. I am specifically talking about the conventional, 30 year, fixed-rate loan. This loan is gold in my book. This is the loan that will not be called due as long as you fulfill your part of the agreement. This loan will maximize cash flow and can even be a hedge against inflation. I am a fan of Dave Ramsey for personal finance (especially if your finances are a mess and you need a simple plan to clean them up) and part of his story is about how all of his loans got called due. Those loans were not these loans. These loans are not callable if you play by the rules. I haven’t read his book in years but I believe he had cross-collateralized and leveraged out pretty far. The current lending environment won’t even allow you to borrow more than 75% LTV (loan to value) thus requiring you to have some equity in your deals. This is why the Dave Ramsey story should be taken with a grain of salt. While any debt carries some risk, there are a lot of ways to hedge agains that risk. Borrowing at historically low rates is one of those ways. Not borrowing 100 percent LTV is another. This is not even an option with conventional loans any more. The closest options to leverage further are in FHA or VA loans – which must be owner occupied (at the start of the loan).
A great lender will look over your tax returns and let you know where you stand. The rules on investment property loans are different than the rules for primary residence loans. The amount of cash reserves required and the LTV (loan to value) have changed throughout our investing years. So have the types of accounts that are allowable sources of reserves. These rules seem to change fairly often; or at least that is what bad lenders blame the complications just before closing on. The banks will also have what they call “overlays” that are more restrictive than the Fannie and Freddie guidelines, in some cases.
This step of the BRRRR process is the paperwork-heavy part. There is no getting around this. Where a private loan requires relatively little paperwork, the conventional cash-out refi will require a sizable stack of papers before and during closing. This is my least favorite step but it is an exciting step because your monthly out-flow decreases since you now have a 30 year loan with a lower interest rate. You also will likely have a month with no payment out (but with rent coming in) which helps pad the bank account even further. Grit your teeth and make the most of it. Get organized during the first one and the subsequent loans will be even smoother. You won’t be having to dig around as much for needed documentation. You’ll be glad you got organized when the next loan comes around.
30 year versus 15 year financing
I am often asked why we choose 30-year financing. While I have nothing against 15 year notes, they don’t fit this stage of our investing career. We want to maximize cash flow and lock in low interest rate loans. If my goal was to own one rental and pay it off ASAP, I might consider a 15 year note. I like the flexibility of a 30 year note because if our strategy changes, we can pay it down quicker but with a 15 year note we can’t just decide to slow down or pay less. This would require a costly refinance at the prevailing rates, which I predict will be higher than those available today on a 30 year notes. The enticement may be a slightly lower rate on the 15 year mortgage and faster pay down. When we get to our goal number of properties, we may begin a pay down process but for now we’ll take the higher cash flow. Cash flow also will allow us to lower rents if we ever need to. We could also better handle a vacancy if all other properties are cash flowing well. I believe that the rate offered on a 30 year note today is better than will likely be available on a 15 year note in the near future. I’m playing the long game and I want the long-term financing at this stage of the game. In future posts we’ll get into some other benefits to these loans.
How many can you get?
Currently you are limited to 10 conventional loans. This may mean one on your personal residence and nine investment properties. After this, you will need to find another type of lender. These terms will not be as favorable. The rate will likely be higher and the term shorter; often with a balloon or adjustment at 5 or 7 years. This can make cash flow more difficult due to the cost of money. This is for another discussion but looking at the options available, it will make the conventional loan look that much sweeter.
The last financial crisis was centered around housing. Lending was one of the causes. The ability to fog a mirror was about all one needed to get a loan. There were all sorts of “low documentation” loans to allow those with less than stellar income or tax returns to get a loan the they may not qualify under more reasonable underwriting guidelines. The pendulum has swung back to the other side. As a reaction (or overreaction depending on your perspective) more regulations were put in place to protect us from ourselves. The result is the limit on the number of conventional loans and the lower LTVs (loan to value) allowed. The upside is that after we do our refinance, we have equity in the deal from the start. We aren’t leveraged to 100 percent of value. We can handle some downturn in the economy without feeling it other than seeing some decrease in our equity.
Now that we have a nice long-term, fixed-rate loan we can just let time work its’ magic. Don’t forget that “P” of PITI (Principal, Interest, Taxes, and Insurance). If you don’t find the cash flow of a few hundred dollars to be inspiring, remember “P”. This amount grows a bit every month. This is your money too. It is just tied up in the equity of your property for now. Oh yeah, and the appreciation is yours as well. And the depreciation (tax benefit we will discuss in the future). And all of the other write-offs. And the leverage. Stay focused and get a little obsessed with this game and it will pay off. Mediocre investments of a few years ago look a lot better now. Time does this. As always “keep the main thing the main thing”!