Playing with Numbers

60%ARV - Loans - Costs - Cash = 0

So, what does that calculation mean?

Actually, it's a calculation I created, but is one that REI's use everyday. It is a calculation used when cashing out equity on a property you just purchased. I was introduced to this by a loan officer I met with a couple weeks back. I didn't fully understand the concept of cashing-out equity immediately, but now that I do, it can be mighty handy.

Let me explain using an example.

Suppose you find a great property to retail. It only needs a $2,000 in cosmetic repairs to market. You are strapped with cash, but know this property has a lot of equity you can tap into. The house has an ARV of $120,000, and you buy the property for $65,000. Since you don;t have the funds for a sizeable downpayment, you get a 100% loan at some ungodly interest rate (it doesn't matter what the interest rate is as you will see). You still need to come up with $1,000 for closing costs, though. Additionally, about $1,000 in costs are rolled into the loan.

So, you close on the property, give the seller their $65,000 and you get a note for $66,000. You then spend a week or two making the necessary repairs, and put the cost on a credit card (or whatever). Now the house is in marketable condition. You now refinance the property at the ARV amount ($120,000) with closing costs of $1,000. Since it's only been a couple weeks at best, you haven't even made a payment on the original loan - hence not caring about the interest rate.

Now, you have an 80% loan ($96,000). You pay off the original $66,000 loan and the remaining 20% balance ($24,000) on the new loan. This leaves you with:

$96,000 - $66,000 - $24,000 = $6,000

You then pay off your repair bill of $2,000 and the amount to refinance ($1,000). You are now left with $3,000 of cash in your pocket for cash reserves, holding costs, or whatever. More importantly, you now have a good rate on your new loan, you don't have to worry about PMI, and your first payment is extended another 2-4 weeks.

Basically, what you've done is this ...

80%ARV - 20%ARV - Loans - Costs - Cash = 0

Since, 80%ARV-20%ARV is 60%ARV, we now have ...

60%ARV - Loans - Costs - Cash = 0

The ARV was $120,000, "Loans" is the amount of any existing loans before refinancing - in our case $66,000. "Costs" include any repair, closing, and holding costs. For this example, costs totaled $3,000. "Cash" in our case was $3,000. Therefore ...

60%ARV - Loans - Costs - Cash = 0
(60%)($120,000) - $66,000 - $3,000 - $3,000 = 0
$72,000 - $66,000 - $3,000 - $3,000 = 0
$6,000 - $6,000 = 0

So, when you find a prospect, you can run the calculation to see if it is a good candidate to cash-out equity immediately. Not all will be a good candidate. Even when you may have a good candidate, you still need to find the people who can make the financing happen.