Cash-Out Refinance

In a cash-out refinance, a bigger new mortgage pays off the old one and the owner keeps the leftover cash. It returns invested cash, which shrinks the denominator of cash on cash return, but the bigger loan raises debt service and shrinks the numerator.

Suppose the default property is worth $600,000 after five years. A 75% loan is $450,000, which pays off the roughly $353,900 balance and returns about $96,100. At 7.25% over 30 years the new payment is about $36,840 a year, and cash flow falls to about $3,370 on the original rent.

Many investors then measure the return on the cash still left in the deal. Here that is about $53,900, so $3,370 is a 6.3% return on it, the same as before. The pulled cash is free to buy the next property. The return of capital entry covers how that money is treated.

Further reading: Cash-Out Refinance on Wikipedia.