Refinancing Your Rental Property: A Strategic Approach to Maximizing Returns

Refinancing is a powerful financial tool when leveraging other people’s money to buy rental property. It can make a good property deal very sweet in the long term, freeing up cash to scale your property business. Refinancing can cover bond and transfer costs or free up cash for much-needed maintenance. With investment property, there’s always a fine balance between tax, profitability and liability – choose two! Refinancing your rental property is the best for profitability and liability:

• An increase in tax saving – more interest that can be deducted from tax due to the loan extension
• Increase in income/profitability due to a lower monthly repayment

Is it Better to Pay Off or Refinance Your Investment Properties?

If you’re looking to draw an income from your properties to live, paying off your investment properties can be profitable. However, there are tax implications, as all rental income is taxed at your normal PAYE tax rate. By refinancing your property, you are effectively postponing profitability from a tax perspective. This in turn frees up cash to scale your property portfolio.

How does refinancing work?

Refinancing an investment property involves replacing the existing home loan on a property with a new one. The term is recalculated from the new application, and the amount is adjusted to the current market value or below. The difference is paid out to the property owner, and the monthly repayment amount is adjusted to the new rate.

An example of how refinancing a rental property works

The Scenario. You bought a property ten years ago at a bargain, and paid a bit extra towards the bond:

• Initial purchase price: R750,000
• Amount paid towards bond: R250,000
• Current property value: R900,000

After ten years of ownership, the property has appreciated, and the owner is starting to show a profit. In the world of rental properties, profit can lead to higher taxes, so the property is refinanced:

• A loan is granted for R 900 000
• R 400 000 is paid to the owner
• The repayment amount is adjusted to the new interest rate and payment term

What can I use the refinanced amount for?

• Subsidise shortfalls in your property portfolio – ie where you have a difference between your rental income and monthly expenses (rates/taxes and levies)
• Expand your property portfolio – If you’re buying more property, you can have funds available for deposits, bond and transfer fees etc.
• Pay back some of the money you have pushed in over the years in your property company
• Upgrade your properties – do much-needed maintenance (e.g. painting) or redoing the kitchen or bathroom

Let’s discuss a few refinancing strategies.

Strategy 1: Cash-Out Refinance for Property Expansion

In this scenario, the property owner refinances for the full R900,000 current value. This strategy provides R400,000 in cash (R900,000 – R500,000 remaining on the original loan) that can be used as a deposit on additional rental properties.

Pros:

• Leverages existing equity to expand property portfolio
• Potential for increased overall rental income
• Diversifies property holdings

Cons:

• Increases debt load
• Possible higher monthly payments on the refinanced property (depending on the term and interest rate)
• Additional properties mean more management responsibilities

Strategy 2: Lower Interest Rate for Faster Repayment

Here, the focus is on securing a lower interest rate while maintaining the same loan balance. The reduced interest payments create additional cash flow, which can be applied to paying off the property faster. You can also refinance your property and keep the money in your investment property bond. You’ll have access to the cash for another investment property. With the lower interest rate, you can repay more towards your bond.

Pros:

• Reduces long-term interest costs
• Accelerates equity buildup
• Potentially shortens the loan term

Cons:

• May not provide immediate cash for other investments
• Savings depend on the difference in interest rates

Strategy 3: Extended Loan Term for Lower Monthly Payments

When you refinance your property you can extend the loan term from 20 to 30 years, resulting in lower monthly instalments. The freed-up cash flow can then be used to pay down the principal faster or cover the shortfall for Krugerrand which has a faster value increase, rather than a rental increase.

Pros:

• Lowers monthly financial obligations
• Provides flexibility in cash flow management
• This can still result in faster repayment if extra payments are made consistently

Cons:

• Potentially pays more interest over the life of the loan if extra payments aren’t made
• Extends the debt obligation timeframe

Important considerations and concerns when refinancing your properties

While refinancing a property can sound like the holy grail, there are some pitfalls and concerns you need to be aware of. These include:

• Refinancing Fees: These can be substantial. Consider negotiating with another bank to cover these fees in exchange for your business.
• Credit Score Impact: Every time you apply for a loan (or insurance quote), a credit check is done. This temporarily (slightly) lowers your credit score.
• Increased Debt: Refinancing often means owing more to the bank, which increases financial risk. Never leverage above your means. Have a property emergency fund ready in case of high interest rates!
• Tax Implications: It’s crucial to use refinancing proceeds wisely. Using the money for personal expenses like holidays can lead to serious tax consequences.

Conclusion

Refinancing a rental property can expand your portfolio, reduce interest rate costs, or manage cash flow. However, approach refinancing with a clear plan and understanding of the risks involved. It could be lucrative when combined with a Section 13sex tax break.

Please don’t use the money to go on holiday, SARS will kill you.

Happy investing!