Types of Loans for Flipping Houses
Traditional Mortgage vs. Private Loan for House Flipping
A house flipping business can create a reliable income, flexible work, and the opportunity to change careers. However, while you don’t need to spend years in an expensive education program to get started, it is not an easy business to be successful in.
To be successful at flipping houses, you will need:
- Proper planning
- Technical know-how
- Accessible funding
Traditional mortgage loans are rarely the right choice for house flipping. So how do you get the best terms on loans when you’re a real estate investor?
Learn why private investors are often the best sources for loans when you’re flipping houses, as well as how to fund your next project.
Mortgage Loans for Flipping Houses
Loans from banks and traditional lenders are relatively inexpensive because their interest rates are among the lowest you’ll find for investment properties. If you’re just getting started with house flipping and plan to occupy the home as your primary residence, a mortgage loan might work.
Unfortunately, in most situations, traditional mortgage loans don't often work for house flipping. There are a variety of factors that make them inconvenient and impractical for this type of business.
Slow to Close
Traditional lenders require that you complete an extensive application, and they go through your finances meticulously. If they see anything that raises questions, they demand documentation, and they take even more time to review your application.
The process rarely takes less than 30 days (45 or 90 days might be more realistic), and investment opportunities often move too fast for that timeline.
If foreclosures or short sales are part of your strategy, you may be frustrated by the speed of traditional lenders.
Traditional lenders base their lending decisions on your ability to repay a loan. They assess how much you earn each month compared to the required monthly loan payments to calculate a debt-to-income ratio.
Mortgage lenders often prefer to see W-2 forms and paystubs as proof of income. If you’re a real estate investor or otherwise self-employed, you might not have the type of income they’re looking for.
Mortgage lenders compare the market value of the property you’re buying to the loan you’re asking for. Known as a loan-to-value ratio, conventional lenders typically prefer to keep that number below 80%, although it is possible to get FHA loans with as little as 3.5% down.
Since the goal of house flipping is to increase the property's value and resell it, the homes you're buying are probably not worth much. But you need enough money to purchase the property and pay for improvements, which might amount to more than the house is currently worth.
Most banks and mortgage lenders require that you have strong credit to get approved for a loan. But if you don't have a history of borrowing, or you have some blemishes in your credit reports, lenders may be hesitant to approve you.
Problems With the House
Traditional lenders prefer to lend money for properties that are in good condition. If there are health or safety issues, the loan is a no-go.
You may intend to fix those problems, dramatically increasing the value of the home for a profit, but lenders are most interested in lending for homes that are move-in ready.
When Mortgage Loans Work Best
It is possible to use traditional home loans to flip a house, especially in the following situations:
- You have significant assets: Assets can sometimes help you qualify—whether you pledge something as collateral or use cash for a down payment.
- You’re not strictly “flipping” the house: When buying a primary residence (where you’re the owner/occupant), you might be able to get funds for both a purchase and improvements using an FHA 203k loan. However, that process is slow and includes numerous restrictions.
- You have significant equity in another property: You might have access to funds from a home equity line of credit or other assets, including real estate, which can provide secured funding.
- You have successful past experience: You may be able to get real estate investment loans from a bank or credit union if you can show you’re experienced in this business. This is more likely if you have knowledgeable partners and financial resources to back you up.
- You can get unsecured loans: You may be able to get a traditional mortgage, then use loans like credit cards or personal loans to fund improvements. This strategy is risky because credit cards are notoriously expensive, and your project will come to a grinding halt if your credit line is cut or frozen unexpectedly.
Private Loans for Flipping Properties
Loans from private lenders ease most of the challenges above. The main drawback is cost, but that may be a cost of doing business. Private loans can come from almost anywhere, but most house flipping loans can fall into two broad categories:
- Loans from people you know
- Hard money loans
When starting out, it will be hard to find anybody willing to give you money. Many house flippers fund their first few deals on their own.
Friends, family, and business associates in your network may be able to extend loans. Once you build up a reputation for successful house flipping, you should be able to start borrowing from hard money lenders. These lenders specialize in loans for flipping and other investments, and they are different from traditional banks.
Private lenders do not require the same amount of time and paperwork as traditional banks. Instead, they evaluate the property itself (both before and after improvements) and your ability to successfully complete the project.
If you’re flipping houses, lenders want to know that the house will sell quickly so they can recover their money. Private lenders will have a lien on the property, allowing them to take possession and sell it if you don’t repay the loan.
Homeowners may also use a home equity loan, a home equity line of credit, or an investment line of credit to fund house flipping projects. However, since these can put your primary residence at risk, they are best for experienced flippers.
Costs of Private Loans for House Flipping
Loans for flipping projects are more expensive than home purchase loans. The interest rate is higher, and you may have to pay several points or origination fees.
Flipping projects are short-term projects. You’re not going to live in the home for decades, so a standard 15-year or 30-year mortgage isn’t the right loan for the job.
Investors often prefer to buy, improve, and sell a property within one year or less, so that’s how most private loans work. Those loans get expensive if you hold a property for a long time because the lender’s risk increases as you delay repayment.
Working with private lenders means interest rates can vary significantly, and everything is negotiable. Interest rates might range between 8% to 20% per year, and you’ll have to pay 1% to 10% upfront. Hard money lenders may also add on extra fees, which can drive up costs.
The longer you’re in business, and the better your relationships with lenders, the less you’ll pay.
To maximize the amount of money available for your project, lenders often allow interest-only payments, and there should be no prepayment penalty. This means you can sell and pay off the loan whenever you are ready.
Tips for Getting Private Loans
As you build your house flipping business, there are steps you can take to increase your chances of finding investors and make yourself more appealing as a business partner.
- Build a network: Getting involved in your local real estate investing community can help you meet people and learn who can potentially lend money. Other investors, real estate agents, and private lenders will see that you’re committed to running a successful business, and your odds of getting a loan will improve.
- Move quickly: With a private lender, the process is different from a standard mortgage loan. Many investors will have their funds available quickly; a week or so is reasonable when you’ve got a good relationship with a professional lender. Your ability to move quickly as well can be a competitive advantage when sellers value speed or there’s a competitive situation.
- Be flexible: Private lenders are in the business of accommodating investors and basing your funds available on a project’s after-repair value. But they might not give you everything at once. You may have to draw from an escrow account as your project progresses. Showing a willingness to be flexible will increase the likelihood that a lender wants to work with you.
- Stake your own equity: Until you have a few successful projects under your belt, lenders will require that you have equity in a project. Be willing to put some of your own money down, or borrow against your own assets, to show lenders that you are serious about your business.
Once you have a history of successful house flipping and have built relationships with private lenders, you should be able to borrow 100% for a project and have multiple properties undergoing work at the same time.