The saying goes “you need money to make money”, fortunately that’s not really true in real estate. It sounds like a good idea to use your own money to buy, rehab and sell a house. You handle 100% of the price and repair costs and when the house sells you get 100% of the profits. The disadvantage here is that you also risk the full amount of the purchase price and repair costs until the property is sold and contracts are signed. This could be a large amount of money that will be tied up for months.
Every house flipper needs to understand the different methods to find financing that will fund flipping a house. Every flip will be different and understanding some creative ways to finance the deal can make each one more profitable. Some methods may require a deeper understanding as you will need to explain how it works to a seller and how they can benefit from your investment.
Methods to finance flipping a house:
- Private Money Lenders
- Hard Money Lender
- Conventional Bank Loan
- Real Estate Crowdfunding Sites
- Cash-Out Refinance Loan
- Home Equity Line of Credit
- Bridge Loan
Using other peoples money, you borrow a small amount for a short period of time to control the property while work is completed. Using a small amount to control a large more valuable asset is called leverage. This is why a 20% down payment permits you to borrow 80% and purchase a property from a bank that is worth the full 100%. Lets look at leverage in general and then discuss some possible methods to raise capital for house flipping.
What Is Leverage For A House?
Basically leverage is ability to use a smaller amount of money to own or control an asset of larger value. The leveraged amount is necessary to control the property and perform any repairs and upgrades that will maximize its value. Leverage allows the investor to use debt to fund a project that returns a profit. It also limits the size of the liability or risk for the investor and increases the potential return.
A non-real estate example: Lets say Tommy is selling a car and his price is $500 but the investor doesn’t want to buy the car. We give Tommy $100 to hold his car priced at $500, the $100 is to control the property for a short time .
We ask around and find a buyer interested in this car and is willing to pay $800 for the car. The seller gets another $400 and the investor profits the $300 difference. If the investor cannot find a buyer the risk is $100 instead of the full $500.
We can use the same principles for attaining capital and performing the first house flip. Depending on the type of lender, they may provide 70% of the property but not the rehab costs or a percentage less where the investor will need to commit more than just time.
Who Are Private Money Lenders?
Anyone who provides a loan to help fund flipping a house is considered a private money lender. They can be close friends or family members that believe in what your doing. They could also be any individual that would like to help or simply looking for a profitable investment for their money. The loan interest is usually high and the loan term is usually short and just for the duration of the flip.
What Are The Requirements?
In this category there usually is no requirements for income or a credit checks like in a traditional bank mortgage. The lender is may be simply looking for a safer investment or at least something that has collateral which is more secure than a business or stocks. Depending on the lender there might be other qualifications such as your team or crews experience, a detailed plan and the estimated return when the house is finally sold.
What Investment Returns Do The Expect?
How the lender is payed back will be negotiated between you and the lender. The lender may wish to receive interest payments monthly instead of after the house is sold and this should be calculated into the cost of the house rehab. Lets look at an example where the lender invests 70% of the property market value at an interest of 12%.
Example
The house market value is approximately $120,000 so you negotiate a buy price at 70% which is $84,000 purchase price.
Loan Total: $84,000 @ 12% = $10,080 total interest
Monthly Interest: $840/month
Flip Duration: 5 months
Total Interest Paid: $4200
In this scenario the fix and flip took about 5 months to complete and at the end of the flip, the full loan amount is paid back. This is a pretty good return considering that most banks will no longer give you much of an interest rate for any of their investment tools. The investor will also need to include the interest payments as part of the cost during the rehab.
The lender risked very little considering that the loan is backed by real property and they can now fund another flip with the same money. If things work out well this lender may stick with an investor for a long time.
What Are Hard Money Lenders?
This type of lender is in it for the short term and they are not interested in your credit score. They are providing the loan to control the collateral, the property, and offering you are high interest rate for a short term 6 month to 2 year terms.
These loans are usually provided by a company, as opposed to the private lender, and their guidelines are looser than any other traditional loan. This is one of the more common methods for finding funding among flippers.
The downside is that they will charge a higher interest rate and will not fund 100% of the project. Most of the sources I found stated that they rarely funded more than 70% of the project price. This means that the investor will need another source of capital for rehab costs.
Can I Use A Conventional Bank Loan?
This is the most well known type of loan because most people will buy their first house getting a 30 year mortgage from a bank and they may understand the costs already. This type of loan is available from any local bank in the area and the process is well defined. Unfortunately for a house flip this method of funding may not be the best solution but could be OK for the first flip.
The conventional 15 or 30 year loan is not very well suited for flipping houses. The process is slow, there are credit requirements and sometimes you will need to have cash to put down to get it. This could be the capital needed for materials and repairs on the house. Not to mention that banks prefer to lend for a property in good shape with no safety or health risks.
Bank Loan Down Side:
- Process takes 45-90 days to complete
- Requires credit and income check
- May require a down payment
- Closing costs are usually higher
- Home market value will need to be higher
- Bank may deny due to safety or health concerns
The down side definitely limits the usefulness of a conventional loan to fund a flip project. This type of project would require that the price of the house is negotiated well below the market value in order to cover more of the upfront cash requirements. The good news is there is an attractive option to still perform your first flip using a conventional loan, the Live-in flip.
Live-in Flip
The reason this type of loan is an option for flipping a house is an investor or new investor can do a live-in flip. With this solution you will live in the house and perform the rehab and repairs over the next few years. With a standard 30 year fixed rate and a pretty well distressed home, you can flip the house in 2-3 years, sell it for profit and benefit from not paying the capital gains taxes.
What About Real Estate Crowdfunding Sites?
Crowdfunding is a more recent concept where the small time investor can help to fund larger projects and see a return on their money. Now the “non-accredited” individual can invest as little as $1,000 on a project and see a profit. In the past the small investors, or mom and pop investors, were avoided because of the administrative requirements and lack of understanding.
This option may not be a good choice for the first time flipper but would work well for the investor that has 1-3 houses flipped in the past 12-24 months. The underwriters have requirements before approving funding to a flipper and this can also include credit checks too. The crowdfunding sites are more cautious about their lending as this is why there are more requirements.
Here are some crowdfunding sites, not listed in any particular order:
- fundrise.com
- realtymogul.com
- groundfloor.us
- richuncles.com
- holdfolio.com
- minnowcfunding.com
- ahpfund.com
- patchofland.com
- realtyshares.com
The crowdfunding platforms is another convenient source of funding for the experienced fix and flipper but this might not be the best idea for the first time flipper. There are requirements such as experience and credit that the first timer cannot satisfy.
What Is A Cash-Out Refinance Loan?
The cash out refinance loan is a way to make the equity in a mortgage available and change the terms of the existing mortgage. Basically you replace the existing mortgage with a larger one and pull the remaining cash out, hopefully the process also reduces the interest rate.
With this method there needs to be some kind of equity in the property to pull out and the bank may limit the cash out to 80 or 90% of the homes equity. The new loan will also have different terms than the current mortgage that may or may not be beneficial.
Example:
The home is valued at $100,000 and the current mortgage balance is $72,000 leaving $28,000 in equity. You want to pull out cash in order to perform some improvements on the property and the bank says they limit this to 80%.
Cash Out: 28,000 x .8 = $22,400
Fees & Closing: $3000
New Mortgage: $94,400 + 3,000 = 97,400
The result is cash in hand of $22,000 with a new mortgage that is almost 100% the market value of the house. If the materials and rehab cost is less than $22,400 then this could be a profitable flip. Or the 22,000 could be used on another distressed property to build your portfolio and eventually target a hard money loan.
Another option is to negotiate a deal with the existing owner of a distressed property and have them do a cash-out refinance or apply for a HELOC to fund the flip. This would be useful if there is plenty of equity in the property and the investor can offer some incentive to the seller for doing this.
Home Equity Line of Credit
The home equity line of credit (HELOC) is another flavor of the cash out refinance. Instead of refinancing the entire mortgage you get credit at a higher interest rate that is equal to the equity in the property. From what I found the HELOC can only be given on the owner occupied primary residence. Again this can be the seller of the home instead of the investor.
One benefit of HELOC over cash out refinancing is that the credit will sit there until a draw is made. The interest and payments are not due until some money is actually used in the line of credit. This offers the investor some time to look for that perfect flip.
Cash out refinance includes all of the traditional mortgage baggage such as credit checks, closing costs, payoff fees and usually takes 45-90 days to complete. Most investors do not recommend using your own money or equity to fund a flip but some investors are starting with no money or credit too.
What Is A Bridge Loan?
The bridge loan (or gap financing) is another type of short term loan that is intended to “bridge” a financial gap involving 2 properties. The terms are usually 12-18 months with a high interest rate and applications fees but it can be acquired in a matter of days and therefore is useful for a rehab and fix. The interest rate is high and can be around 10-12% plus there are fees around 1-1.5% of the loan value and typically you will need around 20% equity to be considered.
These types of loans are used to provide a loan to purchase a new property to bridge the gap while the owner is waiting for the existing property to sell. This could be due to inspections. permit approvals or contractor work completing later than expected etc. When the property does sell the bridge loan is paid in full.
Another option is to use the bridge loan to purchase a home that needs repair. While living in it as a primary resident you can fix it up and then convert the loan to a traditional 30 year mortgage before the 12 to 18 month period ends. The is called a live-in flip.
Can i get a mortgage to flip a house?
Yes, the profit in a flip is decided at the purchase not sale. A traditional mortgage requires more credit, paperwork, fees and time. Calculate your profit before going this route.
Can you really flip houses with no money?
Yes, the idea is that the “money” is not yours. This is how experienced flippers fund their projects, they find investors or use hard money loans to finance the project.