Fix-and-flip financing: Options abound for savvy investors
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. Flipping can be a lucrative, but risky, business.
These shows often fail to show how flippers find and finance their investment property purchases or the cost of renovation. There are actually several fix-and-flip financing options available to investors. Here are five options for financing a fix-and-flip.
When financing a fix-and-flip property, you generally only need the money for around six to 12 months — just long enough to buy the property, renovate it, 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 often is much tougher to get banks to invest in fix-and-flips.
There is an exception: Fannie Mae offers the HomeStyle renovation mortgage program, which is available to investors. With a HomeStyle mortgage, investors can finance the cost of repairs. The HomeStyle mortgage program allows investors to finance 80 percent of the purchase price. The amount financed for repairs cannot exceed 50 percent of the after-repair value. It may be difficult to find a bank that offers HomeStyle mortgages, however.
Hard money 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 lending is ideal for flips because it can be arranged in a matter of days,” said Lucas Machado, president of House Heroes LLC, a company that buys, fixes and resells homes, and is also a hard-money lender. “Home flippers can’t delay securing financing as investor offers typically have no more than 15-day inspection periods and no financing contingency. Hard money loans help the time-pressed flipper because, given that the cash comes from private sources, there is no bureaucratic red tape to stall the process.”
Steve Pollack, CEO and president of Anchor Loans, a hard money lender that specializes in lending to fix-and-flip investors, said his company places about two-thirds of the emphasis on the property, and the remaining third on the borrower. Anchor wants to ensure the property is purchased with built-in equity, and that the borrower’s estimate of the repair costs and after-repair value of the home matches the company’s own analysis, he said.
Although the property itself receives most of the scrutiny, Anchor does evaluate the borrower as well, Pollack said. The company considers how much money the borrower has in reserve to repay the loan and pay for repairs (if the repairs aren’t financed into the loan), and also considers how much experience the borrower has as an investor: How many deals have they previously done, and what type of properties have they done before?
The company also may look at a borrower’s credit history, although credit isn’t the primary emphasis, he said. When new customers become repeat customers, the process becomes easier, he added.
“The vast majority of our lending activity is to repeat clients,” he said. “So, in that particular case, there isn’t a lot of … underwriting that needs to be done, because we already understand who the borrower is — they’ve already performed for us. We’re mostly focused just on underwriting the asset.”
As an alternative to hard money loans, flippers can look for private-money investors, which are similar to hard money lenders, but typically lend out their own money. Private lenders could include friends and family or individuals with a self-directed IRA, for example. As Doug DeShields, president of the National Real Estate Investors Association, puts it, “Private lenders can be people who just have cash and want to get a return that will loan (the money) to you.”
DeShields said it has become easier in recent years to find private financing. Private investors even can operate like a partnership, such as entering into an arrangement with a single investor who is simply looking to make a good return on investment and looking to you to do all the hard work. Such investors generally also have a good handle on the local housing market.
“It’s typically somebody that knows almost as much about fix-and-flips as you do,” DeShields said. “And they can be mentors to you … (and) serve a dual role for you.”
Home equity loans
You can borrow against the equity in your home 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 sufficient funding to purchase and renovate your fix-and-flip venture.
There are three main options for pulling cash out of your home equity:
- Home equity line of credit (HELOC). A HELOC is a line of credit secured by the equity in your home. HELOCs typically come with an adjustable interest rate, which is typically not well-suited for a rising interest rate environment like we’re in now, because the rate could go up. Most HELOCs offer an introductory rate for 6 months to one year, however, so if you plan to fix up and sell the property before the introductory rate expires, a HELOC could be a great way to acquire a property.
- Second mortgage cash out (home equity loan). Like a HELOC, a second mortgage cash-out, allows you to borrow against the equity in your home. A second-mortgage cash-out is a new mortgage — typically with a fixed rate and term, unlike a HELOC — that lets you cash out part of the equity in your home.
- Cash-out refinance. A cash-out refinance allows you to refinance into a new mortgage for more than what you still owe on the home. You then get the difference as cash. Although refinancing generally might not make sense in a rising-interest rate environment, it can be beneficial depending on your goals. For example, you may be able to lower your monthly payment, even if the interest rate is higher, and then use the cash proceeds to acquire an investment property.
Borrowing against your own home can be risky, however, because if something should happen, like a sudden downturn in the economy, and you default on the loan, you could end up losing both properties.
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 also 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.