Photo by Mathieu Stern
What are fix and flip loans and how do they work? If you need help when it comes to taking out your next loan, check out this handy guide.
What has kept you from becoming the next HGTV house flipping sensation? If you said “capital” you’re not alone. Fix and flip loans might be what you need. Lack of available cash often prevents would-be real estate investors from leaping.
House-flipping has become increasingly popular in the past 10+ years. Networks like HGTV have undoubtedly spurred the trend, reaching an 8 year high in 2019. But house-flipping can build up your investment portfolio and help generate a sizable income in a short amount of time.
Most people don’t realize there are special types of loan programs to help. One of the easiest ways to generate funds to get your house flipping project started is a fix and flip loan.
What Is a Fix and Flip Loan?
A fix and flip loan is a short-term, higher interest loan that investors can use to cover the cost of purchasing a property as well as the cost of repairs and renovations. These types of loans are like bridge loans generally used in the short-term until a more permanent financing solution is put in place.
These short-term loans, also known as hard money or private money loans, are a lot different than a regular mortgage loan – it’s designed to help the investor cover the upfront costs of buying and renovating a property. It’s then paid back once the property sells, or is refinanced.
One of the biggest key differences of the hard money, fix and flip loan is the use of collateral. Private lenders or small companies, like Orchard Funding, secure these loans.
They generally consider the real property as collateral and don’t spend a lot of time looking at the borrower’s creditworthiness to loan the funds. All the value is in the property itself.
Fix and flip loans are very short term. Most range from as short as six months up to three years. Flippers who intend to use these hard money loans usually intend to pay off the loan with the profits from the sale of the property. The sooner they can improve the property and sell it, the sooner they can pay off the loan.
The biggest benefit of using a hard money loan is quick access to cash. Many loans can get approval the same day and paid out within a week. That’s in stark contrast to a traditional mortgage which takes from 30 to 45 days to fund.
So, for example, if you find a property at auction, where you must be able to show proof of cash for a purchase within 24 hours, you can get approved for and collect the cash in time to make the transaction.
Why Use a Fix and Flip Loan?
If you’re new to real estate investing, or even if you’re not, a fix and flip loan can help you get funds to buy your real property plus the extra money needed to invest in repairs and renovations.
If you don’t have your own hard cash for the project, then a fix and flip loan is a great alternative.
Most of these fix and flip loans have a lower loan to value (LTV) ratio of around 70% of the value of the property with an additional value of 70% of the renovation costs rolled in. Or you can
But these terms differ from lender to lender. Some hard money lenders will loan up to 90% of the property value and up to 90% of the cost of the renovations.
That gives you, the investor, the funds not only to buy the property but also for the renovations. When you don’t have upfront cash, this is the next best thing.
How Do Fix and Flip Loans Work?
Qualifying for a fix and flip is a lot easier than other more conventional loans. The private individuals or companies that provide these loans don’t look at the borrowers as much as they look at the collateral for the loan – the real property. So, even if you have bad credit, you can still qualify for a hard money loan.
Typically, the lender will have an appraiser come out to value the property to make sure it’s worth what the borrower is asking. Once the property has been appraised, the lender will be able to generate a loan in a much shorter period of time, often within the same week.
The lenders aren’t nearly as concerned about the borrower’s creditworthiness as they are with the collateral. They know that once the property sells, the borrowers will be able to pay off the loan in its entirety.
As more motivation for these hard money lenders, they know they can actually make money from this type of loan even if the borrower defaults on their payment. They can take possession of the property and sell it themselves to make their own profit or turn it into another rental property for their portfolio.
All the risk falls on the borrower. It’s up to you, if you use a fix and flip loan, to make sure all the repairs and renovations are done on time. And then, to avoid defaulting on the loan, you will need to make sure the property sells.
Once you sell your flipped property, you should make a decent amount of profit, even after you pay off the loan.
What You Need to Know
Flipping homes is a lot of work. You will need to make sure you can account for all the expenses. You will need cash for materials, contractors, real estate agent fees, title fees, etc. to get the property to generate a profit for you.
You must get solid estimates on the renovations – or you could end up cutting into your profits if the project goes over budget.
You will also need to consider how much you’ll need in carrying costs. Many flippers forget about carrying costs, which include maintaining utilities, HOA fees, property taxes, insurance, maintenance fees, etc. – the fees it will take to hold the property while you’re trying to sell it.
So, when you’re applying for your fix and flip loan, you’ll want to make sure you get good estimates from your contractors. You might even consider padding your estimate by adding 10 to 15 percent of the original estimates.
And study the real estate market you’ll be selling the property in. A good rule is to try to find a property that you can make a 10 to 15 percent profit on your property resale. If you don’t project at least a $25,000 profit, then it may not be worth the work.
It’s a good idea to know how much real estate agents generally charge for a commission to sell your property. Using an agent is the fastest, easiest way to sell your renovated property and make the highest return (ROI.) But some choose to go the For Sale by Owner route to save the commission.
You will need to decide how you will market and sell your property as you’re considering your fix and flip loan. Most experienced flippers shoot to get the home flipped within 90 days.
Fix and flip loans come with a cost. Because they are short-term and considered more risky than a conventional mortgage loan, their interest rates are generally much higher.
You can expect to pay anywhere from 8% up to 13%. You will also be expected to pay for origination, which will generally run around 1% to 3% of the loan amount.
Because so many things affect the real estate market, it’s unclear how the continuing health crisis will factor in. So far, the real estate market has been steadily climbing.
But some believe impending foreclosures, brought on by the pandemic, will bring on a new era of opportunity for those who want to expand or start their real estate investment portfolio.
If history has taught us anything, its uncertainty usually means opportunities for those prepared to jump on them.
Warren Buffett, one of the most profitable investors of our generation, said, “I will tell you how to become rich. Be fearful when others are greedy. Be greedy when others are fearful.”
Meaning, now that people are unsure of what the future holds, there may be some fresh opportunities around the corner. And learning about hard money lenders and fix and flip loans now will prepare you for those opportunities.
Wherever you are in your real estate investment journey, finding capital doesn’t have to be an obstacle. With hard money lending becoming a big business in itself, your options are greater than ever.
Here at Orchard Funding we specialize in a wide array of financing options, including hard money loans, and provide some of the best fix and flip loan options to fund your projects.
If you’re considering getting your house flipping dynasty started and need to find a great hard money lender for your fix and flip loan, click here to get started with Orchard Funding today.