Just getting into the flip game? You’ll want to know about raising money. Follow this guide on fix and flip loans for beginners.
Doing your first fix and flip can be intimidating. And it’s not just the trepidation over ripping out a kitchen or gutting a bathroom. Financing a flip for investment purposes looks much different than financing your family home. Most flippers don’t use traditional mortgage loans, and it’s for a good reason. They’re not designed for that purpose. Loans for fix and flip investments are often unfamiliar to beginners. Read on to learn more.
What is a fix and flip loan?
A fix and flip loan is a loan all about speed. It’s usually a short-term loan that covers the purchase price of the home and, often, the cost of any necessary repairs or renovations. The most common type of fix and flip loan is a hard money loan.
How does a hard money loan differ from more traditional mortgage financing?
- Timing. A traditional mortgage is designed to be paid off over a long period of time, usually 15 or 30 years. A hard money loan may have a duration of anywhere from three to 18 months.
- Interest rates. Traditional mortgage rates are much lower than fix and flip loans. Rates on a hard money loan run anywhere from 7.5% to 15%. In 2020, traditional mortgage rates were as low as 2.5% for qualified buyers.
- Purpose. Traditional home loans are designed for people buying homes to live in for many years. Hard money loans are meant to be a short-term bridge between the initial purchase, the flip, and the sale.
- Collateral. Most hard money loans and mortgages use the property as collateral.
- Risk. Hard money lenders are often willing to make deals even when a person’s credit isn’t stellar.
Other types of fix and flip loans
- Private money lenders. These could be colleagues, family, friends, or whomever you know who’s got money to lend. Since the deal is between you and someone you know, you may be able to work out more moderate interest rates or payback schedule. Your relationship and reputation with them may be more important than a credit score or your experience flipping.
- Crowdfunding. There are a lot of real estate crowdfunding websites out there that streamline the crowdfunding process. Some allow you to access the money quickly. Others may take more time, a potential negative on a flip. Keep in mind you’ll be beholden to a whole group of people rather than a single lender. Regardless, read the fine print as fees may be somewhat hidden.
- Home equity loan or home equity line of credit. You take this kind of a loan out on a property you already own. It only works if your property qualifies for such a loan. You are potentially risking your current property on the success of your flip.
- Cash-out refinance on a property. Much like a home equity loan, you take this out on a property you already own. That means you’re putting the equity you’ve gained on the first home into your flip.
- Investment or acquisition line of credit. This type of financing is taken out on a property you own but don’t live in, like a rental property. It’s not generally available to new flippers.
What’s the catch?
Fix and flip loans offer benefits to flippers when done right, but they’re risky in a way that a traditional mortgage is not. That’s because you’re buying a place that needs work using a loan with high interest rates—and you’re doing it all on a tight timeline. Here’s how to make sure you do it right.
Understand the numbers. A successful flip is, above all, one that makes money. It’s crucial to run all the numbers before buying a flip, no matter what kind of financing you use. A lot of investors like to start with the 70% rule, which suggests you not pay more than 70% of the After Repair Value (ARV) of a property. This number needs to take into account any money you’re putting into repairs.
The 70% rule only works if you’re correct about the amount of money it will take to renovate. Tip: Always assume it will cost more than you think, by at least 20%. You also need to be right about the price you can get for the property after renovation. Knowing what comparable homes sell for, being honest with yourself about the home’s condition and location, and keeping tabs on changes in the local real estate market are all keys to properly pricing an investment home for sale.
Before you commit, understand all the costs. You’ll want to account for the purchase price, the renovation cost, the carrying costs (not just around the financing of your loan but also monthly fees for things such as electricity or HOA expenses), and selling fees. You also want to add a financial cushion for when the unexpected happens.
How to shop for a fix and flip loan
Look for a lender that specializes in fix and flip loans. You want a lender that understands the mechanics of house flipping. Ideally, choose a lender from a recommendation by someone who’s used the lender for flips and been happy with their services. A good lender can help you make the right decisions on a flip.
Stay local if possible. While it’s possible to source a fix and flip loan outside of your area (including online), there are advantages to shopping local, especially if you’re looking to make house flipping your primary business. When you build up a relationship with a local lender, you’re adding to your portfolio of business experts. This includes everyone from real estate agents to contractors to real estate investment lawyers.