Loans for Flipping Houses: Tips for Funding Your Business
A house flipping business can provide a healthy income and the opportunity to change careers. Based on popular television shows, it seems easy to do, and you don’t need to spend years in an expensive education program to be successful.
Unfortunately, it’s not as easy as it looks. Proper planning and technical know-how are essential, but the greatest roadblock might be funding—it takes money to make money. So how do you get the best terms on loans when you’re a real estate investor.
Private investors, including people you know and hard money lenders, are the best sources for loans when you’re flipping houses.
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.
Mortgage Loans for Flipping a House?
Traditional home loans are probably not an option for buying investment properties—at least when you’re starting out. However, if you’re going to occupy the home as your primary residence and you can adapt to the problems below, mortgage loans might work.
The good news is that loans from banks and traditional lenders are relatively inexpensive: Interest rates are among the lowest you’ll find for investment properties (but you’ll still have to pay closing costs). Unfortunately, these loans are not always practical. Read on to see why.
Slow to Close
One of the biggest challenges of a traditional lender is the time it takes to close a loan. Lenders require that you complete an extensive application, and they go through your finances with a fine-toothed comb. 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. If you’re a real estate investor or otherwise self-employed, you might not have the type of “income” they’re looking for (lenders like to see W-2 forms and pay stubs).
How Much Is the Property Worth?
Lenders also compare the market value of the property you’re buying 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. When you’re buying a house for flipping, it’s probably not worth much in its current state. But you need enough money to purchase the property and pay for improvements, which might amount to more than the house is even worth. The home’s after repair value (ARV) would be a better measure, but traditional lenders only consider a property’s current appraised value.
Most banks and mortgage lenders require that you have strong credit to get approved for a loan. But you might not have a history of borrowing, or you may have some blemishes in your credit reports. That doesn’t mean you can’t successfully flip houses, but lenders may be hesitant to approve you.
Alternative lenders are more interested in your previous projects than your credit score.
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. Keep in mind that you may lose that property in foreclosure if you can’t keep up with the payments on your new loan, so this option is risky (especially if your family lives in the property you borrow against).
- You have experience with successful projects in the past: You may be able to get real estate investment loans from banks and credit unions if you convince them that you’re experienced in this business. It’s even better when you have knowledgeable partners, a solid process, and financial resources to back you up.
- You can get unsecured loans: If you’re able to borrow without pledging collateral, you may be able to use loans like credit cards or personal loans to fund improvements. You still need enough money to buy the property, but additional funds could come from an unsecured loan. 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 (plus, you need high credit limits).
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. People who know you (and who might not have much money or tolerance for risk) could be your only option. As a result, you may need to fund your first few deals on your own.
The tips below may make it easier to borrow money.
- Build a network: Get involved in your local real estate investing community. Over time, you’ll meet people, and you’ll learn who can potentially lend money. Moreover, people get to know you. Other investors, real estate agents, and private lenders will see that you’re committed to running a successful business (not to mention competent), and your odds of getting a loan will improve. Eventually, 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.
- Fast closing: With a private lender, the process is different from a standard mortgage loan, and you might receive funds relatively quickly (a week or so is reasonable when you’ve got a good relationship with a professional lender). Moving quickly can be a competitive advantage when sellers value speed or there’s a competitive situation.
- Asset-based lending: Instead of looking through credit reports and calculating income ratios, private lenders tend to focus on the value of the asset you’re buying. If you’re flipping houses, the lender wants to know that they can sell the house quickly to recover their money. Like other lenders, private lenders will have a lien on the property, allowing them to take possession of the property and sell it if you don’t repay the loan.
- Purchase and improvements: Private lenders are in the business of accommodating investors and basing your funds available on a project’s ARV. But they might not give you everything at once—you may have to draw from an escrow account as your project progresses.
- Flipping with no money? Until you have a few successful projects under your belt, lenders will require that you have equity in a project. At some point, you may be able to borrow 100% for a project and have multiple projects running at the same time.
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.
One point is one percent of your loan value.
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, and that’s how most private loans work. Those loans get expensive if you hold a property for a long time, and that makes sense because the lender’s risk increases as you delay repayment.
How much does it cost to borrow for flipping? Costs are all over the board, and everything is negotiable. Interest rates might be anywhere between 8 to 20% per year, and you’ll have to pay 1 to 10% upfront. 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 so that you can sell and pay off the loan whenever you are ready.