Overview
Before you purchase your first flip property, you need to consider how you are going to fund the purchase and repairs.
Real estate is an expensive industry to start a business. According to Zillow, the
median house price in the United States is $254,900, and real estate can be much more in urban markets on the East & West Coasts. Once you factor in other costly expenses such as your buying costs, holding costs & repair costs, you could easily need over $300,000 in capital just to fund one flip project!
Fortunately, you have many different funding options to fund your flip projects, even if you have little to no cash in your bank account.
In this lesson, we will discuss the different Loan options you can use to fund your house flipping business.
Using Your Own Cash
If you are fortunate enough to have enough investable cash to fund your own flip projects, you could simply write a check to purchase the property and fund all of the project expenses.
Paying cash is fast, easy, cheap and makes your offers very attractive, but there are drawbacks to paying cash as well.
Pros of Using Your Own Cash to Fund Your Flips
- Attractive Offers- Seller's generally prefer cash offers because there aren't any financing contingencies or hurdles that could prevent the deal from closing.
- Close Faster - With an All Cash Offer, you can close faster because you don't have to waste time dealing with lender paperwork, appraisals & inspections.
- Easier Acquisition & Management - Eliminates the lender paper work at closing and eliminates the hassle of on-going draw requests and draw inspections to get your money for the project.
- Cheapest - Eliminate expensive lender loan origination fees & points (2-4% of loan value) and interest payments (5% - 15% depending on the lender).
Cons of Using Your Own Cash to Fund Your Flips
- Hard to Scale - The main problem with using your own cash is that you likely won't have enough cash-on-hand to purchase more houses to scale your business. Unless, you have millions of dollars in the bank, at some point you are going to have to use other people's money (OPM) to fund your projects.
- No Leverage/Lower ROI
Use Other People's Money
If you aren't fortunate enough to have an endless supply of your Own Cash at some point you will have to use 'Other People's Money' to scale your business. The most common way to use 'Other People's Money' is to get a loan from a lender, but we will discuss some creative strategies that can be used to fund your projects as well.
Benefits of Using Other People's Money
- More Purchasing Power - One of the most important benefits of using OPM, is it gives you more purchasing power to purchase additional properties and scale your business.
- For example, let's say a flipper has $150,000 to invest in their house flipping business in a market where the average distressed property is selling for $100,000, needs $50,000 in repairs & resells for $200,000. In this example, the flipper would have to dedicate 100% of his capital to one single project. If the average project takes 4 months to flip, the flipper will only be able to flip 3 houses per year.
- On the flip side (no pun intended), if the flipper raised outside funding and put 25% down, the flipper would be able to flip 4 houses at a time or 12 houses per year. In other words, this extra purchasing power allows the flipper to scale the business 4x faster!
- Higher ROI - With less cash invested in each deal, an investor can achieve a higher ROI from the profit earned on the project.
Cons of Using Other People's Money
- More 'Expensive' - Using a lender is more expensive than using cash. You will have to pay your lender a monthly interest payment, points upfront & other fees.
- Close Slower - Generally, a hard money lender can close in as little as 7-14 days, so this is not a significant issue, but it does take a little longer than a cash purchase.
- More Paperwork & Documentation - Lender's will generally require more paperwork upfront at closing and documentation during the rehab in order to receive your 'rehab draws'.
- Less Attractive Offer- Seller's may find a financed offer less appealing due to the increased risk that the property may not meet the lender's underwriting requirements which could prevent the deal from closing.
Reality check
Remember: Using Other People's Money is definitely more 'expensive' than using your own Cash, but using OPM is just a 'necessary evil' and 'cost of doing business'. As long as you remember to include the Financing Costs in your analysis, you shouldn't worry about the 'expensiveness' of the Loan.
You need to switch your negative perceptions of lenders and think of funding as a resource that can help you acquire more properties, make more profit and scale your house flipping business.
Loans for Flipping Houses
There are an abundance of resources that you can use to help you get funding for your rehab projects which each have their own advantages and disadvantages.
- Hard Money Loans
- Small Local Community Banks
- Private Investors
- Crowd Funding Lenders
- Traditional Financing
- HELOC
- PELOC
- Creative Financing
Hard Money Loans
Hard Money Lenders specialize in providing loans for flippers and real estate investors, which is why Hard Money Lenders are often times the best option for funding your rehab projects. Hard Money Lenders provide 'investor friendly', short-term Loans for fixer-upper properties that Conventional lenders typically avoid. Hard Money Lenders can generally close fast and provide funding within 7 to 10 days, which will make your offers more competitive and appealing to home sellers.
Hard Money Lenders generally charge 10 to 16% interest, and 2 to 3% points upfront, but those terms will vary depending on the deal, borrower's experience and financial situation.
Pros of Hard Money Loans
- Easier Underwriting Requirements (than Conventional) - Hard Money Lenders can lend on fixer-upper properties that Traditional Lenders typically avoid.
- Investor Friendly Loan Terms - Hard Money Lenders provide short-term (6 to 12 Months), interest only loans that are perfect for quick fix-and-flip projects.
- Potentially Larger Loan Amounts/Less Money Out of Pocket - Some Hard Money Lenders offer financing for the Purchase + Rehab, or lend a up to 80% of the ARV. In some circumstances you may need very little money out of pocket if the HML Terms are generous.
- Deal Based Lending - Instead of lending based upon the Borrower's financials, often times Hard Money Lenders will lend based upon the numbers of the deal so they can lend to borrowers with sub-par credit.
- Fast Closing - Hard Money Lenders can close and provide funding within 7 to 10 days of the purchase agreement.
Cons of Hard Money Loans
If not managed correctly, hard money loans can be costly. Typically, borrowers will make monthly interest-only payments with a balloon repayment of the principal at the term’s end. It is critical to carefully consider the optimum loan period for your project. Borrowers must accurately assess their property’s After Repair Value and thoroughly research local market conditions to be confident they can pay the loan back on time, avoiding additional penalties or possible Default.
The interest rates on a hard money loan are higher than a conventional bank loan. Most borrowers will pay between 8% and 14% for a hard money loan, although it could be higher or lower depending on the borrower’s experience, the value of the property and other considerations. The loan-to-value ratio for hard money loans also tends to be more conservative than for traditional loans. Lenders want to be sure they’ll recoup their investment, so the loan-to-value ratio may only be as high as 70% of the value of the property.
- Relatively Expensive - Hard Money Loan terms are typically the most expensive loans available on the market at 9 to 12% interest & 1 to 3% points upfront.
- Paperwork/Documentation - Relative to Cash closings, Hard Money Lenders will require additional paperwork upfront for closing and project documentation during the rehab.
- Loan Draws - Unfortunately, Hard Money Lenders do not give you all of the money upfront. Your HML will require you to submit a Loan Draw request that includes Contractor Invoices, Lien Releases & Proof of Completed Work in order to receive your Loan Draw.
Reality check
Hard Money Lenders may seem like an expensive option, but HMLs provide investor friendly terms & fast closings that Traditional Lenders cannot match. For this reason, you should strongly consider building relationships with Hard Money Lenders in your area that you can use to fund your rehab projects.
Another loan option to considers is Local Community Banks & Portfolio Lenders. Local banks and portfolio lenders generally lend their own money as opposed to lending money insured by Fannie Mae, Freddie Mac or HUD, which gives them more flexibility for lending on local flip projects.
Pros of Local Community Banks
- More Affordable Rates - Rates will likely be more expensive than conventional rates, but more affordable compared to Hard Money Loan rates.
- More Flexible Underwriting than Conventional Lenders - Loans are not government insured, so they do not have to meet strict underwriting requirements which gives them the flexibility to lend on local rehab projects.
- Relationship Based Lending - Local banks are easy to contact and more relationship based than a traditional lender.
Cons of Local Community Banks
- Stricter Underwriting than HML - Although Community Banks are more flexible than Conventional Lenders, they may have stricter underwriting than a HML.
- Slower Closings - Community Banks generally, won't be able to close as fast as a HML, but should be faster than a Conventional Lender.
- Paperwork/Documentation - Similar to HMLs, Community Banks will require additional paperwork/loan documents upfront and require Loan Draw requests during the rehab to get your money.
PRO TIP
Get in-touch with some Local Community Banks and ask if they have a branch that lends on local real estate deals and fix-and-flip projects. Build a relationship with their branch manager and discuss your goals to establish whether their Community Bank can provide funding for your rehab projects.
Private Investors/Private Money Lenders
Private Investors (aka Private Money Lenders)are generally high net worth individuals that you already have a relationship with that are within your social circle that have a high amount of capital or savings that they could invest in funding for your deals. A Private Money Lender could be:
- Family
- Friends
- Neighbors
- Local Millionaires
- Local doctors, lawyers or executives
- Individuals with sizable retirement savings in 401ks or IRAs
- Random investor you meet at a Local REI Networking Event
Using Private Money can provide a win-win situation for both you and your lenders.
Your Private Lenders may not be satisfied with their current portfolio performance in the stock market or they may have a pile of cash sitting in their bank account burning a hole in their pocket. You can offer your Private Lenders an alternative investment opportunity that could net them a 7 to 12% annual return on their investment to help them diversify their investments and put their money back to work.
As a rehabber, working with Private Money Lenders is generally easier and more flexible than working with Hard Money Lenders. The loan terms are completely negotiable so you can generally negotiate more competitive rates for your deals than Hard Money Loans.
Pros of Private Money Lenders
- Relationship-Based/Deal Based Lending - Instead of lending based upon the Borrower's personal financial situation, Private Money Lenders will often lend based upon your relationship, reputation and the numbers of the deal.
- Negotiable Rates & Flexible Loan Terms - The terms of a Private Money Loans are completely negotiable between the borrower and the lender so you can typically negotiate better rates and terms with a PML than you could with a HML.
- No Underwriting Hassles - Traditional Banks & Hard Money Lenders have strict underwriting guidelines, but Private Money Lenders lend based upon their comfort level with you and your due diligence of the deal.
- No Draws or Inspections - Hard Money Lenders & Traditional Banks don't give you all of the money upfront and typically require progress inspections before they will release a draw for the work that has been completed. With PML you can negotiate your own terms to receive all of the funding upfront so you don't have to deal with rehab inspections and draws.
- Unlimited Number of Deals - "You network is your net worth!". The number of deals you can do is limited by the amount of funding you have available for your business. If you have a large network of Private Money Lenders you could have an endless supply of funding that can be used to scale your business.
Cons of Private Money Lenders
- Mixing Business with Pleasure - Rehabbing houses can be a risk and stressful business and working with friends, family or people within your social circle can amplify the drama, so be sure to remain professional.
Real Estate Crowdfunding Lenders
Crowdfunding is the process of funding projects by raising small amounts of money from a large number of people that was often used to raise money for charitable causes or benefits. The concept of 'pooling money' for real estate has existed for decades, but with new legislation in 2012 and new innovations in real estate, Crowdfunding platforms are becoming a popular option for funding fix-and-flip projects and real estate deals.
Real Estate Crowdfunding platforms raise small amounts of money from a large number of Private Investors that is pooled together to fund local rehab projects. These platforms provide a connection between Private Investors that have extra money and local rehabbers that need money to fund their rehab projects.
Real Estate Crowdfunding platforms offer similar rates and terms to HMLs with rates between 10 to 16% and 2 to 3% points upfront, but these rates will vary depending on the borrowers experience, qualifications & financials.
Pros of Crowdfunding Lenders
- Easier Underwriting Requirements (than Conventional) - Hard Money Lenders can lend on fixer-upper properties that Traditional Lenders typically avoid.
- Investor Friendly Loan Terms - Hard Money Lenders provide short-term (6 to 12 Months), interest only loans that are perfect for quick fix-and-flip projects.
- Potentially Larger Loan Amounts/Less Money Out of Pocket - Some Crowd Funding Lenders offer financing for the Purchase + Rehab, or lend a up to 80% of the ARV. In some circumstances you may need very little money out of pocket if the HML Terms are generous.
- Fast Closing - Crowd Funding Lenders can close and provide funding within 7 to 10 days of the purchase agreement.
Cons of Crowdfunding Lenders
- Experience/Financial Qualifications - Since Crowdfunding Platforms are lending other investor's money, borrowers typically have to have a track record of successfully completed projects in order to qualify.
- Relatively Expensive - Crowdfunding Loan terms are typically the most expensive loans available on the market at 10 to 16% interest & 2 to 3% points upfront.
- Paperwork/Documentation - Relative to Cash closings, Crowd Funding Lenders will require additional paperwork upfront for closing and project documentation during the rehab.
- Loan Draws - Unfortunately, Crowd Funding Lenders do not give you all of the money upfront. Your HML will require you to submit a Loan Draw request that includes Contractor Invoices, Lien Releases & Proof of Completed Work in order to receive your Loan Draw.
Traditional Loans/FHA 203k Loans
Traditional Loans or mortgages are the most common and cheapest loan type home buyers use to purchase their personal residence. Unfortunately, traditional lenders have strict underwriting standards established by FHA, FNMA & HUD that prevent them from lending on fixer-upper properties that are not in livable condition. For this reason, you may have trouble finding a conventional lender to underwrite a loan for a fixer-upper property that needs substantial repairs.
With that said, FHA offers a loan product called the FHA 203k loan which can be used for both the purchase and rehab costs, but unfortunately the loans are only available to owner-occupied buyers.
This could be a decent option if you are interested in doing a 'live-in' flip where you rehab your own personal residence and then sell the property after a few years of ownership.
Pros of Traditional Loans
- Cheap - Generally, traditional loans provide the cheapest interest rates available to purchase real estate (4 to 6% depending on term).
- Small Down Payment - Down payments will vary depending on the loan product, but FHA loan down payments can be as little as 3.5%
- Live-In Flips - If the property is good enough condition and is 'under-writable', conventional loans can be a good option for 'live-in' flips of you own personal residence.
Cons of Traditional Loans
- Strict Underwriting - Strict underwriting requirements make it difficult for flip projects to qualify.
- Problems with the House - Traditional Lenders will not lend for properties that are not in 'livable condition'.
- Need Strong Credit - Most Traditional Lenders require you to have strong credit to get approved for the loan.
- Income Requirements - Traditional Lenders will also evaluate how much your earn compared to your monthly loan payments to calculate your debt to income ratio.
- Loan Limits - Traditional Lenders generally only lend up to 80% of the property value, which means you have to cover the other 20% down payment, as well as the repair costs & other costs out-of-pocket.
- Slow Closing - Closing typically takes 30 to 60 days which can be a deal-killer for sellers that want to close quickly.
HELOCs
If you are a homeowner with equity in your property, you could use a Home Equity Line of Credit to 'tap-in' to the equity to get a line of credit that can be used to fund your
house flipping business.
A HELOC is similar to a Home Equity Loan, but instead of you receiving a lump sum of cash, you receive a 'credit account' that is secured by your property. With your HELOC you can borrow cash up to the approved credit limit and only pay interest on the amount you borrow.
Pros of HELOCs
- Leverage Non-Performing Assets - HELOCs allow you to cash-out existing equity in a non-performing asset that is not providing a return-on-investment, and re-investing it into a performing asset that can generate a return.
- Low Interest Rates - Generally, HELOCs rates often provide the most competitive rates available and are typically in line with Conventional Mortgage rates.
- No Closing Costs - HELOCS If you have good credit, you typically won't have to pay an application fee or any closing/appraisal costs.
- Pay Off HELOC Whenever - HELOCs offer the flexibility to pay off your loan whenever you wish. Note: some HELOCs charge a fee if you payoff the loan to early or don't maintain a minimum draw balance of funds per year.
- Use the HELOC for Whatever - Unlike other funding options, you do not have to justify your plans for the money with a HELOC, so you can use the HELOC to fund your rehabs.
- No Project Documentation/Rehab Draws - Hard Money Lenders & Community Banks require documentation, inspections & proof of work completed before funds are released. With HELOCs you can draw as much money as you need, and when you need it without the hassle of draws.
Cons of HELOCs
- Decreasing Home Values - If your home decreases in value, you could end up underwater on your home loans, owing more on your mortgage and HELOC than your home is worth.
- Rising Interest Rates - HELOCs are generally adjustable-rate loans, but as interest rates continue to rise so will your adjustable rates.
- Hidden Fees - Beware of hidden fees such as early termination fees or minimum loan balance fees.
PELOCs (Portfolio Line of Credit)
If you are an investor that has a portfolio of properties you could use the PELOC to 'tap-in' to the equity in you real estate portfolio.
Similar to a HELOC, a Portfolio Equity Line of Credit allows take out an equity line of credit against your portfolio that you can use to fund additional purchases and your rehab expenses.
Creative Financing Options
Sometimes you have to get creative in order to fund your projects and use a combination of all of the funding options listed above.
For example, some investors will use a Hard Money Lender to fund the purchase of the property, and use their own cash to finance the repairs & other project costs.
Other investors that may have little to no money and may need to structure financing that gets them 100% financing for the project.
