House flipping is becoming increasingly popular, especially due to the increased availability and flexibility of financing. And with the rising cost of housing, those increased profit margins are looking more and more attractive to investors.
Real estate purchases can be expensive to say the least, depending on your area. There are several ways to finance a home, but how do you get a loan for house flipping? Let’s first dive into some house flipping basics.
The Costs of Flipping Homes
The idea of purchasing a home, renovating it and quickly turning around and re-selling it may sound easy, but there can be significant costs to doing so. Don’t make these beginner house flipper mistakes – here are all the hidden costs you’ll want to make sure you’re keeping in mind if you’re flipping houses.
In addition to the cost of renovations, if you’re getting a traditional loan, you may need to put more money down since it isn’t going to be your “primary” residence and considered an “investment” property. This is because it’s seen by lenders as a “riskier” venture. Some lenders won’t even work with inexperienced flippers, or they’ll charge super high fees and interest.
You’ll also want to account for property taxes, active income and/or short term capital gains taxes resulting from the sale, utilities, and homeowners’ insurance while you’re rehabbing the property, until the property sells and closes. As you can imagine, all of these costs can majorly eat into your profit so you’ll want to make sure you’re considering them when you’re running numbers on a property!
Private lenders are individuals that have capital they’re willing to loan to you. In fact, there’s a lot of people willing to give loans, especially to real estate investors, for a fee, interest, or stake in the property or profits. Most lenders will charge between 8-12% interest and 0-2 points for a loan, which can be significantly lower than a hard money lender.
Private lenders also offer more flexibility and room to negotiate than conventional lenders or hard money lenders. They may even be willing to act as a partner in the deal if they have some experience in the real estate industry, lending both their money and expertise. You’ll want to vet private lenders and make sure they’re a good fit for you and what you’re looking for , and if they’re not, there’s likely one out there that will be!
So how do you vet private lenders? Ask them about their experience in lending or ask to speak to previous flippers they loaned money to. Questions like these may be beneficial for you to ask:
- How quick was the money received?
- What were the terms?
- Did the lender communicate well with them?
- Did the lender offer any expertise?
Private lenders can be a risky option, though, since they’re not affiliated with any sort of company or held to the same guidelines and regulations as conventional lenders. There’s the possibility that the lender doesn’t come up with the promised amount of money and the flipper loses earnest money on a home they put an offer on, or there could be hidden fees. Make sure you have a solid contract with any lender, properly vet them, and find out if they’re trustworthy so you don’t end up in a pickle!
Hard Money Loans
These loans are a common occurrence in the house flipping world, and usually have terms of less than one year. They can be more flexible, and more people can qualify for them regardless of their income situations. This makes them a popular option for house flippers.
However, these positives and flexibility comes at a cost – usually to the tune of 12-18% interest rates, plus 2-5 points. Though you may not have to pay those points until the home sells and you’ve paid back the loan, rather than when you’re purchasing & initially closing on the property, which can be helpful for flippers strapped for cash.
So if they don’t qualify you based on income, what do they use to determine who qualifies for a loan? Hard money lenders base the amount you qualify for a loan for on a percentage of the home’s after-repaired value (ARV). This percentage is usually around 70-80% of the ARV, depending on the lender. This means that if the home costs $100,000 but the ARV is actually $180,000, then you can borrow up to $126,000 (in the 70% scenario). After paying the $100,000 purchase price, this leaves $26,000 left for renovations, closing costs, lender fees, points, and interest, carrying costs (utilities, taxes, etc.), and other selling expenses like staging, marketing, and real estate agent commissions.
Depending on the area you live in and the market, $26,000 for all of those expenses may not cut it and you may have to come up with the rest of the cash you need yourself. Or you may be able to take out another loan from a private lender to cover additional costs if you aren’t (or don’t want to) pay anything out of pocket.
Hard Money Loans vs. Conventional Loans
One major difference between conventional loans and hard money loans is regulations and red tape. Conventional banks are bound by certain guidelines, rules, and regulations, while hard money lenders are not in terms of lending for real estate transactions. According to Investopedia, often times, conventional loans won’t be given for properties in poor conditions because they don’t satisfy those guidelines for traditional mortgage financing.
Hard money lenders are able to evaluate the property for the value it could have based on the renovations proposed and the reliability of the home flipper. They also take into account the market and if the deal is justifiable regarding the potential resale value. Sometimes they’ll want to see an applicant’s tax returns, bank statements or credit reports, but many don’t use it for qualifications for loans. If those documents pose an issue for your credibility, you’ll likely be able to shop around for a different hard money lender with different guidelines & criteria they follow to determine loan suitability.
So where do you find these hard money lenders?
Your best resources are house flippers in your area or researching online for hard money lenders in your area or in the virtual space. Searching online is also helpful because you can compare lenders more easily, by getting a handful of quotes and comparing them side by side.