Cash-out refinance math for rental properties

The formula

The lender sets a loan-to-value (LTV) limit, the largest loan it will make as a share of the appraised value. Investor cash-out loans often have a lower limit than loans on a home you live in. The exact limit depends on the lender, the loan type and the market, so treat any number here as an example, not a quote.

From the new loan, the old loan is paid off first. Then closing costs come out: lender fees, appraisal, title and so on. You get what is left.

Worked example

Made-up numbers for a single rental you have owned a while. They are not a quote and not the calculator's starting numbers.

• Appraised value: $400,000
• Lender LTV limit: 75%
• Current loan payoff: $180,000
• Closing costs: 2% of the new loan
• NOI (rent after vacancy and operating costs): $28,000 a year
• Current loan payment: $1,000 a month principal and interest

The math:

• New loan: $400,000 x 75% = $300,000
• Closing costs: $300,000 x 2% = $6,000
• Cash out: $300,000 - $180,000 - $6,000 = $114,000

That is the headline. Now look at what it does to the monthly numbers.

The new payment

Say the new $300,000 loan is at 7% for 30 years. The monthly payment is $1,995.90, or $23,950.80 a year.

• Before: cash flow $28,000 - $12,000 = $16,000 a year, about $1,333 a month. DSCR $28,000 / $12,000 = 2.33
• After: cash flow $28,000 - $23,950.80 = $4,049.20 a year, about $337 a month. DSCR $28,000 / $23,950.80 = 1.17
• The payment rises by $23,950.80 - $12,000 = $11,950.80 a year

So the $114,000 costs about $11,951 a year in extra payments, which is about 10.5% of the cash. Part of each payment is principal, so not all of that is lost: in the first year, roughly $20,900 of the new loan's $23,951 in payments is interest. Still, the property now has much less room for a vacancy or a repair.

If the new rate is higher than your old one, you also pay the higher rate on the $180,000 you already owed. That hidden cost is easy to miss when you look only at the cash.

The DSCR cap

Many investor loans also have a DSCR minimum: NOI divided by the yearly payment must be at least, say, 1.20. That can cap the loan below the LTV limit. Using the same made-up numbers:

• Largest yearly payment at 1.20: $28,000 / 1.20 = $23,333.33, or $1,944.44 a month
• Loan that $1,944.44 a month pays off at 7% over 30 years: about $292,266
• Closing costs at 2%: about $5,845
• Cash out: $292,266 - $180,000 - $5,845 = about $106,421

The DSCR test gives a smaller loan than the LTV test ($292,266 against $300,000), so it wins. Your cash drops by about $7,600. The lower of the two caps always sets the loan. For more on the ratio, read DSCR explained.

Is it worth it?

Cash from a refinance is borrowed money, not profit. It makes sense when the cash goes somewhere that earns more than it costs. A simple test: compare the extra yearly payment with what the cash will earn.

• If the $114,000 becomes the down payment on another rental that cash flows $9,000 a year, that covers most of the $11,951, and you also own a second property that pays down its own loan.
• If the cash pays for a car or sits in savings, the property just carries a bigger loan.

This is the heart of the BRRRR method: buy, fix, rent, then refinance to pull most of your cash back out for the next deal. The refinance step uses exactly this math, with the after-repair value as the appraised value.

Before you apply

• Get a realistic value. Look at recent sales of similar homes. An appraisal that comes in low cuts the loan directly.
• Ask each lender for its LTV limit, DSCR minimum, rate, points and seasoning rules for investor cash-out loans.
• Ask for a loan estimate so you know the real closing costs, not a guess.
• Check for a prepayment penalty on your current loan.
• Run the new cash flow with honest NOI, including vacancy and repairs.

FAQ

How much can I cash out of a rental?

Roughly the new loan minus your current payoff and closing costs. The new loan is capped by the lender's loan-to-value limit and, on many investor loans, by a DSCR minimum. The lower cap wins.

Is cash from a refinance taxable income?

Loan money is generally not treated as income because you have to pay it back, but tax rules have details. Ask a tax professional about your situation.

How soon after buying can I do a cash-out refinance?

Many lenders want you to own the property for some time first, often called seasoning. The rules vary by lender and loan type, so ask before you plan around a date.

Does a cash-out refinance lower my cash flow?

Usually, yes. A bigger loan means a bigger payment, and a higher rate makes it bigger still. Check the new cash flow and DSCR before you sign.