If you’re considering purchasing properties to fix and flip but don’t have the cash, you’ll need a loan to help get started. House flipping is an investment in real estate, it involves purchasing comparatively inexpensive homes that often need work, then fixing them up and selling them for more than you paid. House flipping can be lucrative but comes with significant financial risk, especially for beginners. Let’s dive into how to secure financing for your flip.
Key Takeaways
- Flipping a house generally costs more money than buying one as a home.
- Lenders see flipping as risky and generally won’t work with inexperienced flippers.
- Consider vetting private lenders by speaking to other flippers.
- Flippers can try crowdfunding sites to finance their investments.
- If you are trying to save money to buy a fixer-upper to flip, bear in mind you will need to cover not only the mortgage cost and renovations but also the taxes, insurance, and utilities until you sell the home.
The Costs of Flipping Homes
While buying, fixing, and reselling properties can be profitable, it costs more money to flip a house than to buy one to live in. Not only do you need the money to buy the property, but you also need funds for renovations and then the property taxes, utilities, and homeowners’ insurance for the period from the moment the sale closes to the day it’s sold to someone else.
Short-term capital gains tax rates are 10% to 37%, depending on your federal income tax bracket, and will cut into any profits you earn if you flip within a year. The long-term capital gains tax rates are 0%, 15%, or 20% of the profit, depending on your income. These take away less of your profits but will be offset by the tax, utilities, and insurance needed to hold the real estate longer.
If you don’t have the cash to buy, getting started in house-flipping is not easy. Even if you qualify for a loan with a down payment, you’ll pay more when borrowing to finance a flip than for a primary residence. That’s because lenders see flipping as riskier: those paying for their primary home are more likely to pay than if the loan is part of an investment.
Many lenders will not work with inexperienced flippers. They will want to see that you have a successful track record of selling at least one home for a profit. Others will work with an inexperienced flipper but charge higher fees and interest.
Hard Money Loans
Hard money loans are typically secured by the property, not your creditworthiness. They are usually offered by private investors or companies as opposed to banks or other traditional financial institutions. Hard money loans are characterized by their short duration, high-interest rates, and relatively high closing costs.
The appeal of a hard money loan lies in its flexibility and speed of funding, which can be critical if you’re looking to close a deal quickly. The terms are typically much shorter than traditional loans, often ranging from one to five years, and the property itself is the collateral. Lenders also tend to put up a lower percentage of the cost to buy these properties than if you were buying it as your home, all to ensure, along with the higher interest rate, that they can recoup their cost in case of a default.
The loans usually have terms of less than one year and interest rates of 12% to 18%, plus two to five points. A point equals 1% of the loan amount, so if you borrow $112,000, you would pay an additional $2,240 if two points are added to your loan. Rather than pay points at closing, as with a conventional mortgage, you may not have to pay points until you sell the home on a hard money loan—the one soft thing about this hard money.
Most hard money lenders expect interest-only payments each month while the loan is outstanding, but some may allow the interest to accrue without payments until the flip is complete. It might be worth asking your lender if you can wait to pay interest after you sell.
Hard money lenders base the amount you can borrow on the home’s after-repaired value (ARV). If a house costs $80,000, but the ARV is $160,000, and you can borrow up to 70% of ARV, you can borrow $112,000. After paying the $80,000 purchase price, you’ll have $32,000 left for closing costs (though you can negotiate for the home’s seller to pay them), lender fees, rehab, carrying costs, and selling expenses. These include staging, marketing, and real estate agent commissions. If you can stick to your budget, you shouldn’t need any money out of pocket to flip the home.
The $2,240 in points will take up a significant chunk of that $32,000 budget, though, and if you’re paying 15% interest for six months, your total interest on $112,000 will be $8,400. After these two significant expenses, you’ll have just $21,360 for everything else—less if you had to pay closing costs. But if the home does sell for $160,000, you’re looking at a $48,000 profit, minus taxes, for six months of work, potentially without writing a single check from your bank account.
Hard Money vs. Conventional Loans
Hard money loans are easy in one way: the lack of red tape involved. Unlike conventional banks, lenders aren’t bound by guidelines about the quality of the real estate at the time you buy it. If the purchase and repair cost versus the resale value makes sense and the home flipper is trustworthy, a hard money lender will make the loan.
In evaluating the flipper, hard money lenders aren’t usually worried by borrower qualifications such as debt-to-income ratios and credit scores. In some cases, they may want to see an applicant’s documents, such as tax returns, bank statements, and credit reports, but they generally aren’t concerned if you are borrowing the funds for the down payment.
A hard money lender, like a bank, will hold the first position lien on the home until you repay the loan. Nevertheless, you’ll be the owner and hold the deed in the meantime.
Where to Look for Lenders
In 2022, the U.S. had a modest decline in the average profit margin from house flipping, an effect of a softening market on the heels of rising interest rates. In 2023, according to Attom, house flipping profitability continued to plummet. In 2023, mortgage rates almost tripled from the lows in 2021, significantly increasing the cost of borrowing, which affects the prices you can sell at and how much you need to pay for your loans from flipping.
One place to find a hard money lender is online. For example, Lima One Capital works with new flippers and lends up to 92.5% of loan-to-cost (LTC) or up to 75% loan-to-ARV. Fees and interest rates decrease the more experience flipping you have. Lima One lends in most states, with rates and fees varying by state. Borrowers with credit scores lower than 680 can borrow slightly less and pay the highest costs. The minimum credit score is 660. Also, Lima One Capital requires a 10% down payment and offers repayment terms of up to 24 months.
Note
Closing costs vary depending on the lender. Expect origination fees between 1.5% and 5% (or more), depending on the project’s scope, and an interest rate between 3% and 6.5% and up, depending on your credit score and other factors.
Another firm, Kiavi, offers fix-and-flip loans for up to 90% of the purchase price and 100% of the renovation costs. You need to submit bank statements to show you can cover the down payment and closing costs. Other requirements include a purchase contract, a list of past fix-and-flip projects, property documentation, and the down payment.
Private Lenders
A private lender is simply an individual with substantial capital to loan you. There are individuals looking to generate income on their capital without putting forth the labor of flipping a house. Private lenders will operate much like a traditional lender, though you may be able to get better rates and terms.
Some private investment groups focus on funding real estate projects, including house flipping. These groups pool money from multiple investors to provide financing for various real estate ventures. Joining or seeking funding from such groups can provide access to a larger pool of capital.
You can find private lenders at local real estate networking events. Typically, they charge interest, plus zero to two points, though this vary by lender Like a hard money lender or a bank, they will take a first-position lien on the house.
How to Vet a Private Lender
Experienced professional flippers say the best way to measure a private lender you’re considering is to speak with other flippers—you can find and meet them at real estate networking events—and ask if they have experience with certain lenders. You’ll have many questions: How quick was the turnaround? What price did they receive? How responsive was the lender? You can even ask for references and call them.
The worst-case scenario is usually that a deal falls through because the lender doesn’t provide the promised funds, and the buyer loses their earnest money deposit. Another possibility is being surprised at the settlement table by unexpected lender fees. There is also the potential for legal battles over contract terms or a lender trying to catch a borrower in default so they can foreclose on the property. These are all good reasons to check out a lender before signing anything.
Online Private Lenders
Technically, a private lender is a friend, family member, or another individual who doesn’t make a business out of lending money but agrees to give you financing. Some companies may call themselves private lenders simply because they are privately owned. Like hard money lenders, you can also find them on the internet.
Anchor Loans, a company based in Calabasas, California, can close deals on a wide array of property types in 48 states. Terms vary by state. According to the company, flippers can borrow up to 95% of the cost of the home and will loan between $50,000 to $10 million, and loans may be approved in up to five to 10 days.
A down payment of at least 10% to 20% of the acquisition cost is required. Borrowers must have a proven track record of at least three flips in the previous 12 months. Anchor Loans says it considers loans to qualified corporations and multi-member limited liability companies with fewer than five flips.
Crowdfunding
Crowdfunding relies on a group of individuals and institutions to collectively finance loans. Each lender, called an investor, supplies a small percentage of the borrower’s loan and earns interest on that money.
Traditional crowdfunding sites like Prosper aren’t geared toward buying and flipping houses. Prosper’s maximum loan amount of $50,000 is intended for projects like home renovation, debt consolidation, and small-business funding. That’s where specialty crowdfunding sites for residential real estate flippers come in. Some will prefund your loan, meaning the company will quickly close your loan using its own money while it waits for investors to put up funding. Others wait for the investors to put up the funding first, which could mean a slower closing.
Crowdfunding Sites
Some of the best real estate crowdfunding sites offer investors opportunities for competitive returns, and some crowdfunding sites lend money to people for real estate projects.
Groundfloor offers loans in 31 states from $75,000 to $750,000 with the financing of up to 100% of loan-to-cost (depending on experience), closings in up to three weeks, no payments during the loan term, and no tax returns or bank statements required for loans under half a million. Interest rates start at 7.5%, and Groundfloor says it can roll points into closing.
Borrowers must pay at least three months of interest even if they repay the loan sooner. Typical closing costs are $1,250 plus a $250 closing fee, and Groundfloor says it charges two to four and a half points per loan. All points and fees can be rolled into the loan. Groundfloor typically does not work with inexperienced flippers.
Another option is Upright (previously Fund That Flip), which offers $50,000 or more in funding, covering up to 90% of LTC and 100% of construction costs. Repayment terms can be as long as 15 months, and loans are available in 35 states.
Crowdfunding Drawbacks
The crowdfunding process for evaluating and committing to a deal can be slower than what a borrower would experience with a private or hard money lender. Once a flipper has a solid relationship with a lender, the two can close a deal in 24 hours when a great opportunity arises if all the paperwork is in order.
Unlike private lenders, crowdfunding sites also may not offer the opportunity to negotiate. They may have set parameters for each deal because they are responsible for many investors.
Can I Flip a House With a Traditional Mortgage?
Yes, it’s possible to flip a house with a traditional mortgage from a bank. However, banks often have stricter underwriting requirements and may expect a larger down payment, which can be difficult for some house flippers to meet.
How Many House Flippers Make Money?
There’s no guarantee that you’ll turn a profit when flipping houses. If you buy the wrong home, the market slows down, or you run into unexpected issues, you could lose money. According to data from April 2023, about 13.5% of homes sold by investors sell for less than the investor paid. This doesn’t include homes that sell for more than the investor paid, but not enough to recoup rehab costs.
What Makes a Home Good to Flip?
For a house to be good to flip, it needs to be priced cheaply enough that you can purchase it, fix it up, and sell it for a profit. Flippers also try to complete their sales quickly, so a home needs to be in a location with a strong market, limiting the risk that the flipper will need to hold the home for long.
What Can Go Wrong When Flipping a House?
There are lots of things that can go wrong when flipping a house. Running out of funds, not having enough skill or time to renovate the property correctly, and not being able to sell for the price needed to cover costs and include profits can lead to failure.
The Bottom Line
If you don’t have enough cash to flip a house without financial help or have the cash but want to limit your risk, there are several ways to get funding. A hard money lender, private lender, or real estate crowdfunding site can help you get underway. All these options are more expensive than traditional mortgage financing for an owner-occupied home. Still, their price reflects the high risk the lender is taking.
Read the original article on Investopedia.