Fix-and-flips often rely on nontraditional financing
5 common fix-and-flip financing options
- Conventional lenders
- Hard money
- Private investors
- Home equity loans
If you watch any home-improvement TV shows, then you're probably familiar with the term "fix-and-flip." It refers to purchasing an inexpensive home in need of extensive repairs — often a foreclosed property that a bank wants to get off its books — and then putting a lot of time, money and sweat into renovating that house so you can sell it for a profit.
These shows do a decent job of demonstrating how much hard work is needed to get a house ready to sell. They are not so good at showing you how to get the financing you need to purchase the house and pay for renovations.
The biggest issue with financing fix-and-flips is that you generally only need the money for around six to 12 months — just long enough to buy the property, renovate it, list it with a Realtor, sell it and use the proceeds to pay off the loan (and hopefully turn a profit). So you can expect to pay higher interest rates. In addition, banks make their money on loans by charging interest over long periods of time, so they are often not interested in short-term loans. You can get a conventional mortgage to invest in a rental property because you plan to keep the property and pay off the loan over time by renting it out. It is much tougher to get banks to invest in fix-and-flips.
Because of this, many house flippers turn to hard money lenders. These lenders typically represent small groups of investors that lend money for real estate at high interest rates over short periods of time. Interest rates can range from 8 to 18 percent or more, depending on your creditworthiness and the nature of the real estate venture. You also pay premium fees for hard money, which means you will need to pay anywhere from 1 to 5 percent of the loan amount to the lender at closing.
Hard money lenders have several advantages for home flippers, however. They are generally more interested in the outcome of the venture than in your credit history. So, they will want to know everything they can about the property and your renovation plans, but may not worry as much about your credit score. Hard money lenders also base their loans on the value of the property after renovation. So, while you typically can get only 65 percent of the value of the home from a hard money lender, that percentage is applied to the appraised value after renovations.
For example, if you plan to purchase a home for $100,000, and your appraiser believes the property will be worth $200,000 after repairs, you may be able to get as much as $130,000 from a hard money lender, which is more than enough to purchase the home and begin renovations. Hard money lenders will still want you to have some skin in the game, such as a downpayment, to keep you motivated to finish the project. In addition, if you don't need to make $30,000 worth of renovations, they may not lend you as much, or they may raise their fees to keep you "in the game."
If you don't want to go the hard money route, you can look for private-money investors. These are very similar to hard money lenders, but they are typically lending out their own money. This arrangement is much more like a partnership. It's another way to fund your fix-and-flip ventures — where you enter into an arrangement with a single investor, for example, who is simply looking to make a good return on investment and looking to you to do all the hard work. Terms for private-money investors vary widely, so you will need to do some homework.
Home equity loans
Another option for first-time home flippers is refinancing your primary residence to get a cash-out loan or opening up a home equity line of credit to get the funds needed to invest in your home-flipping business. These avenues only work if you have enough equity built up in your primary residence to secure enough funding to purchase and renovate your fix-and-flip venture. That financing method also is incredibly risky, because if something should happen, like a sudden downturn in the economy, you could end up losing both properties.
Finally, the newest option for house flippers is crowdfunding. This isn't like trying to get a single product to market through the online fundraising platform Kickstarter, however. Real estate crowdfunding works more like hard money lending, where groups of investors can come together to fund your project. These investor groups typically charge high interest rates, but can be cheaper than hard money lenders and have no up-front fees. Real estate crowdfunding is relatively new, however, and may require that you have experience with house flipping just to apply.