Due to a number of popular television shows, most people know the premise of buying and flipping properties. An investor acquires a fixer-upper, makes the necessary improvements and, hopefully, sells it for a big profit. In 2017, the average profit on a flipped house was $63,143, which means the practice can certainly be a worthwhile investment. Financing for these purchases can be complicated because traditional mortgages are generally not an option, especially for those flippers who are just starting out. Other traditional loans also take a lot of time to acquire and generally rule out anyone with less than great credit. Fortunately, those people wanting to get into the flipping business do have a number of other financing options.
Why a Fix/Flip Loan?
Getting enough money to buy and renovate a house can be a big challenge. Most lenders want to keep the LTV, loan to value ratio, below 80%, meaning borrowers will need to come up with a 20% down payment. For commercial real estate, the LTC, or loan to cost ratio, is considered. That simply means the ratio of financing to the construction cost, which most lenders want to keep below 80% as well.
The houses involved in a fix and flip are obviously often not worth much as is. They need extensive renovation. That’s why flippers need a lender who will consider the homes ARV, after repair value, which should be a substantial improvement. Traditional loans are usually based on the property’s current appraised value, so those lenders prefer properties that are already in good condition. That’s why those who want to fix and flip usually need to look elsewhere for their money.
Types of Fix/Flip Loans
These loan options are often an excellent way for they buyer to make money, but they do come with heightened risk and higher EBC, effective borrowing costs, the total cost of borrowing which includes appraisals, origination fees, loan fees, etc.
Hard Money Loan
These non-bank loans are a popular option for buyers who plan to quickly sell a property after buying and renovating it. In general, these loans, also known as rehab loans, are easier to get than traditional loans, and they are fast. Borrowers can sometimes apply for and receive their money in approximately two weeks. If the property has enough potential, lenders will work with people with credit issues.
Drawbacks of these loans include higher interest rates, usually between 10% and 20%. Buyers will often pay higher fees as well. The loan is short-term, meant to last for approximately a year. Borrowers can also expect their lender to release the money in partial payments so they can make certain renovations are being done correctly and on time. The home buyer sacrifices some control with this type of loan.
Home Equity Line of Credit
Some people use the equity in their own homes to secure an HELOC, which means using residential assets for a commercial endeavor. The bank allows them an amount based on the home’s equity, or amount that they have paid for, versus the remainder of their mortgage. The money is available, but the homeowner may use some, none, or all of it. For those with at least 20% equity in their home, this option may work, especially since they only pay interest on the money that they actually use.
The interest rates on these loans are favorable and lower than many other loan rates. Banks will let owners borrow up to 85% of their home’s value minus the balance of the original mortgage.
Since the borrower’s home is the collateral for this loan, they can lose their primary residence if they cannot keep up with the payments, so an HELOC should be carefully considered.
Often, one person brings the construction and market expertise and another brings the financing. Established flippers may be able to bring on a financing partner who brings the money for the purchase and the improvements. While entering into this agreement, the partners decide how the profits will be divided, which usually depends whether the investor provides more than the money. If a home sale is profitable, everyone is happy. If not, they divide the loss according to the previously determined percentage. The flipper can end up making a healthy profit or be responsible for a significant loss.
Other financing possibilities include investments from family and friends or acquiring a personal loan. Some people even tap into their retirement funds. All of these options carry risk as well as the possibility of reward. No buyer should bet everything on a flip project.
Fix and flip loans differ from traditional financing in a number of ways. Borrowers need a loan that can be processed quickly, unlike traditional mortgages, which can take months to finalize. They are usually a short-term loan, and a borrower’s credit history is less important than the real estate’s profit potential. While these fix and flip loans are more flexible, they also have higher interest rates and often carry more risk as well as lender involvement.
Obviously, flippers with a successful history have access to more financial options, but beginners can break into this market. As always, people should seek professional financial advice before beginning the borrowing process.