In a perfect world, it would be possible to take out home flipping loans with the same low-interest rates and repayments as a traditional mortgage. However, the simple reality is that more often than not, banks are unwilling to provide the capital a house flipper needs to execute a fix and flip. This is primarily because of the risks involved. While you can generate profit very quickly when flipping houses, it’s also true that you can potentially lose money, especially if it takes a long time to sell the house after the repair work is done.
Fortunately, you aren’t limited to traditional financial institutions, and there’s a variety of ways for real estate investors to fund a successful flip. This guide outlines the most common approaches.
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Option 1: Traditional Loans
Can you take out a traditional loan to flip a house?
Put it this way. In most cases, the answer is no. The underwriting rules and regulations that banks are legally obliged to follow make it very difficult for traditional loan providers to actually grant you a loan to flip a house.
This one of the main reasons why hard money lenders exist. The red tape and bureaucracy that banks are required to follow increased dramatically in the aftermath of the 2008 global financial crisis. As a result, it is no longer realistic to expect a bank to approve a loan for a real estate investment that is considered risky by default (house flipping).
If you choose to pursue this option, you need to start the conversation with your bank of choice long before you start vetting properties to flip. You also need to have a:
- Very high credit score
- High salary
- Very low debt-to-income ratio
Even if you meet all these criteria and apply long in advance, it’s still possible that your application may be rejected. Fortunately, there are other ways to finance flips that don’t require an angelic financial track record.
Option 2: Home Equity Loans & HELOCs
There are some important differences between home equity loans and HELOCs (Home equity line of credit), but the underlying principle is the same. In essence, you are using the equity in your existing home to fund the purchase of a fix and flip.
It is worth clarifying that equity is the difference between your home’s value and the outstanding mortgage amount. In other words, if your home is worth $250,000, and the outstanding mortgage amount is $150,000, you have $100,00 of equity that you can potentially tap into.
- With a home equity loan, you receive a lump sum of cash, which can then be used to fund the fix and flip project.
- With a HELOC you are granted a credit account, where the credit limit is determined by the equity in your home.
If you have equity in your existing bond, it can be one of the most affordable ways to fund a house flipping project. However, there are two primary issues with Home Equity Loans & HELOCs
Issue 1 – You need to be a homeowner: This is obvious but it still needs to be said. You can’t use this particular option if you don’t already have a home loan to leverage.
Issue 2 – You are limited by the equity available: If you are still early in your loan’s life cycle or your house hasn’t appreciated much since you bought it, you may not have a huge amount of equity to play with. This can be very limiting when attempting to execute a fix and flip.
Option 3: Hard Money Fix And Flip Loans
Why do people use hard money lenders?
Because a reputable hard money lender is faster, more convenient, and far more likely to approve your loan than a bank is. With fix and flip loans, you can also access the following benefits:
- Online applications
- Fast closing
- Instant proof of funds
- Flexible loan terms
- Lower credit score requirements
- Interest-only payments
- Built on the asset-based lending model
Fix and flip loans are built on the asset-based lending model, where the underlying value of the asset being purchased acts like an insurance policy for the lender. If the borrower fails to make their repayments or pay back the loan when it concludes, the lender can effectively claim ownership of the house by initiating a foreclosure.
What are the downsides when using a hard money loan?
- Higher interest rates than a normal mortgage for a primary residence
- A significant down payment is required in most cases
- You have to pay back all the capital in one big balloon payment when the loan expires
- If you default on the loan, the lender can initiate a foreclosure
- Your closing costs and origination fee may be higher than a normal loan
How do you apply for a hard money loan?
If you work with an efficient lender like New Silver, the entire application process can be completed online, in less than 15 minutes.
With that being said, hard money lenders do have certain requirements. To be more precise, you need:
- 600+ Minimum Credit Score
- 10-20% Down Payment
- Experienced flippers may be charged a lower interest rate
On this point, it’s worth noting that house flipping experience is advantageous, but not technically required. Don’t let this throw you off. Hard money lenders can help you flip your first investment property, even if you have little to no experience as a real estate investor.
How do hard money loans work?
There are 3 basic things you need to understand about hard money loans.
1. The loan terms are really short: Unlike a traditional 30-year mortgage, hard money loans usually range from 6-24 months, with the option to extend the loan if the house flipper needs more time to sell the house.
2. There is a 100% Balloon Payment At The End: It may come as a surprise to learn that you pay back 100% of the capital borrowed when your hard money loan concludes, in one single payment. There are two main reasons for this. Firstly, it alleviates cash flow issues that would inevitably arise if the capital had to be split over the monthly repayments. Secondly, it is commonly understood that the money generated from the sale of the investment property will be used to pay back the loan in full.
3. Your loan amount is determined by the cost of the project, or the after repair value of the house: You basically have two options when assessing the amount that the lender is willing to provide.
Loan To Cost: This is short for loan-to-project cost. If you expect the house to cost $250,000, the cost of repairs to be $30,000, and all other costs $20,000, your project cost would be $300,000 (ie the sum of the house, repairs, and all other expenses that you are likely to run into during the flip).
The loan cost ratio that lenders are willing to offer usually ranges from 60-90%, but this obviously depends on which lender you use. Staying with the example above, if the project costs $300,000, and the lender offers a loan-to-cost ratio of 90%, you would qualify for a maximum loan of $270,000 to fund your fix and flip project. The shortfall would need to be provided by the property investor.
Loan To Value: This is short for loan-to after repaired value. After repair value (ARV) is a realistic estimate of what the house will be worth once the renovations are complete. Most lenders are willing to offer 60-80% of the after repair value, but again this is dependent on which loan provider you choose.
To use a quick example, if the home is likely to be worth $400,000 after the rehab work is complete, and the loan provider offers 75% of the ARV, you would qualify for a $300,000 loan. On this point, it’s worth noting that New Silver has a free ARV calculator that you can use to help figure out the value of the home after the rehab work is complete.
Furthermore, if you already have a basic understanding of the house price bracket that you are thinking about flipping, this easy-to-use hard money calculator can give you a quick and accurate estimate of the costs involved, including monthly repayments, repair costs, and the potential ROI.
Option 4: Private Lenders
Private lenders are often used to supply the capital needed for house flipping. The Corporate Finance Institute defines a private money loan as a loan that is given to an individual or company by a private organization or even a wealthy individual.
Why do people use private lenders?
There are two main reasons to use a private lender
- Reason 1 – You can potentially set very attractive loan terms
- Reason 2 – If your current credit score is low, a private lender may be your only option
What are the downsides when using a private lender?
Large sums of money can complicate interpersonal relationships very quickly
If the wealthy individual is a family member, close friend, or respected colleague, you need to tread very carefully when executing the fix and flip. When you choose this road, both the house and the integrity of the relationship are on the line.
Lack of regulation and potential legal issues
In this case, the lack of regulation can come back to bite you. Where hard money lenders and traditional loan providers will use standardized contracts when drawing up the deal, an agreement with a private lender may present unique opportunities and challenges
It really doesn’t matter how well you know the person. You need to read the fine print of the agreement, and should also consult a legal professional before signing anything. Even a small misunderstanding can be very costly, and this is especially true if the flip doesn’t go according to plan.
Huge variations from lender to lender
Unlike a company with standardized offers and contracts, private lenders may come in all shapes and sizes, with massive discrepancies between each lender and even the terms that the lender is willing to offer investors
In some cases, this can be a dream come true if you get offered a low-interest rate and terms that favor the borrower. However, the terms could also be structured in such a way that is far more favorable to the lender. This is a particularly big risk if you are an inexperienced house flipper.
Ultimately, private money lenders can be a blessing or a curse, depending on which investor you work with and how much profit you make during the flip. Given all the other choices available to you should only really consider this option if you have a low credit score or a very secure relationship with the investor providing the capital.
Option 5: Crowdfunding
How does crowdfunding work with house flipping?
The defining characteristic of the crowdfunding model is that the loan is ultimately provided by a collection of investors, rather than a single institution or lender. It’s easy to see the attraction for investors that provide capital to crowdfunding platforms. They can often make between 6-12% back on their seed capital, over relatively short time periods.
It is only in recent times that crowdfunding has become a viable option for house flippers. This is mainly due to advances in online crowdfunding technology, and the symbiotic relationship between the house flipper and the crowdfunding platform.
The house flipper needs capital, while the crowdfunding platform needs short term investment opportunities with high-profit potential. If everything goes according to plan, it’s a win-win for both parties.
What are the upsides to crowdfunding your flip?
- The interest rates can be comparable to hard money loans
- Certain crowdfunding platforms are fully catered for flippers
- Crowdfunding is a valid alternative to hard money lenders
What are the downsides to crowdfunding your flip?
- Some crowdfunding platforms have a slow lending process
- The terms of the loan may be very inflexible. This can be problematic for some investors.
- Each platform needs to be researched and vetted before you can consider using it
- There are a limited number of reputable crowdfunding platforms to choose from
In the end, it should be pretty clear that there are a variety of ways to fund a fix and flip. Tapping into your existing home equity can be one of the most cost-effective approaches, while hard money loans are a very good option for real investors that need quick access to capital, legal protection, and reasonable interest rates considering all the risks involved.