There's a lot of money to be made in the flipping business, if done correctly. However, the costs associated with buying a house to flip and completing any necessary repairs and renovations can be prohibitively expensive.
Fortunately, you can get a loan to fund your fix-and-flip project that can make the out-of-pocket capital requirement far lower. Here's a quick guide to how loans for flipping houses work, what to expect during the financing for flipping houses application process, and the pros and cons of borrowing money for flipping houses.
Can you get a loan to flip a house?
The short answer to this question is yes -- a real estate investor can get a loan to flip a house. However, the process is different than when you're buying a home to live in or an investment property to rent out. Traditional mortgage lenders don't loan money for fix-and-flip projects, and even if they did, you don't really need a 15- or 30-year mortgage for a house you're planning to rehabilitate and sell within a year or so.
Instead, you'll need to go through a hard money lender or other type of private real estate lender. In a nutshell, these money lenders are companies that loan money on real estate with the intent of getting repaid quickly. Generally, hard money loans are used for flipping houses, but they can also be used as bridge loans before longer-term financing can be obtained.
What are the benefits of getting a loan to flip a house?
There are several reasons to get money loans for your next house-flipping project, even if you can afford to complete the project in cash. Just to name a few:
Increased buying power
As you'll see in the coming sections, fix-and-flip loans have rather low down payment requirements in many cases. I've seen reputable hard money lenders who will finance as much as 90% of a property's purchase price and 100% of all repair costs for a qualified investor. Using borrowed money to fund your real estate house flipping project can dramatically amplify your buying power -- and profit potential.
Less money at risk
In most cases, fix-and-flip real estate loans are made to limited liability companies (LLCs) or other business entities, not personally to an investor. This can help protect your personal assets in case something goes wrong.
Pursuing multiple projects
Even if you have the cash on hand to fund your fix-and-flip project, getting a loan allows you to only commit a small amount of capital. This leaves the rest of your money available to pursue additional investment opportunities.
How do loans for flipping houses work?
Most loans for flipping houses, whether from a hard money lender or private real estate lender, have terms of six to 18 months, and 12-month fix-and-flip loans are most common, but there are exceptions. Some have an initial term with an option to extend. They generally have a fixed interest rate for the duration of the loan, and most are structured as interest-only balloon payment loans.
In other words, if you get a 12-month loan, you'll make monthly interest payments for 12 months, and then the entire principal balance would be due at the end. However, some lenders give investors the option of not making any payments at all and simply repaying the principal plus accumulated interest at the end of the term.
Loans for flipping houses are designed to cover the entire cost of the project -- specifically, the cost of the house itself plus the cost of renovations and repairs. Maximum allowable loan amounts depend on the individual lender but are generally calculated in two ways, and you'll be limited by whichever produces the smaller loan amount:
- Loan-to-Cost (LTC): The loan amount as a percentage of the project's anticipated cost.
- Loan-to-Value (LTV): The loan amount as a percentage of the property's projected value after repairs and renovations are completed.
Just to name one example, private real estate lender LendingOne is willing to lend up to 90% of a project's cost, but no more than 75% of its anticipated after-repair value.
How do you qualify for a house-flipping loan?
Qualification for fix-and-flip loans works differently than qualifying for traditional mortgages. When you apply for a traditional mortgage (to buy a home to live in), the deal is mainly about you. Sure, the property has to meet some sort of appraisal standard, but traditional mortgages mainly rely on your ability to repay the loan.
On the other hand, qualification for house-flipping loans is more focused on the property itself and your business plan for it. For example, does the home's after-repair value (ARV) justify the loan? Are the renovation budget and timeline realistic? In a nutshell, the loan-to-value ratio and loan-to-cost ratio are likely to be more important to a lender than your income and personal assets.
What documentation will you need?
In addition to filling out an application, you should be prepared to submit certain documentation when applying for a fix-and-flip loan. This may include, but is not necessarily limited to:
- Bank statements, for either yourself or whatever entity (LLC, etc.) you plan to use.
- A copy of your driver's license or other government-issued ID.
- An LLC operating agreement (if applicable).
- An executed sales contract for the property.
- A list of any other properties you (or your LLC) own.
- Documentation of other fix-and-flip projects you've completed.
- Your personal tax returns.
- Estimates from a licensed contractor for any proposed repairs or renovations.
Do you need house-flipping experience?
You don't need experience in flipping houses to get a loan for this purpose. There are plenty of lenders that are perfectly willing to loan money to inexperienced real estate investors, as long as the numbers make sense.
Having said that, not all lenders will deal with first-time house flippers, and those who do are likely to give less favorable terms than they would to borrowers with several successful flips under their belts. It may also be beneficial to get a real estate license to add to your experience.
Do you need a great credit score for a house-flipping loan?
I mentioned earlier that the main basis for qualification for a fix-and-flip loan is the property, not you personally. However, the lender will still want to check your credit score to gauge whether you have a history of paying back debts as agreed.
Credit score requirements are pretty flexible when it comes to house flipping investors. For example, LendingOne requires a minimum FICO score of 600 for a fix-and-flip loan, which is in the realm of "fair" credit. Most other hard money and private lenders have similar requirements. Like with most other types of credit products, borrowers with higher credit scores tend to get the best loan terms, but you don't need outstanding credit to qualify.
How much of a down payment will you need?
Lenders typically want an investor to have some skin in the game, but your out-of-pocket requirement can vary significantly from lender to lender. As I mentioned earlier, most lenders use two limiting factors -- the project's loan-to-cost (LTC) and loan-to-value (LTV) ratios.
When it comes to loan-to-cost, most lenders want a maximum of 90%, but it's quite common for lenders to separate the cost of the home itself and the cost of repairs. For example, one lender will finance up to 90% of the property but will finance 100% of all renovations.
On the loan-to-value side, lenders typically limit the loan to a maximum of 75% of the projected as-completed value. Your loan will be limited to the lower of the loan-to-cost or loan-to-value methods.
Here's how this works. Let's say you want to buy a property for $200,000 and plan to spend $100,000 on repairs and renovations. Afterward, you expect to sell the property for $350,000. Your lender will finance as much as 90% of the cost of the project ($270,000) or 75% of its after-repair value ($262,500). Because the latter method produces the lower amount, you'd be limited to borrowing $262,500 toward the cost of the project.
Can you get a fix-and-flip loan in the name of an LLC?
You can get a fix-and-flip loan to you personally, but as mentioned earlier, they are generally made to a business entity such as an LLC. In fact, most hard money and private lenders prefer to make house-flipping loans to LLCs, and some will only make loans to LLCs.
What are the potential drawbacks of house-flipping loans?
While it can certainly be beneficial to get a loan for a house-flipping project, there are some downsides to this approach that investors should be aware of before financing their first fix-and-flip. Just to name a few:
One of the big expenses you need to consider when calculating your break-even point and projected profit for a fix-and-flip project is the carrying costs, which refers to the money you're spending while you own the property. For example, if you own the property for a year, you can expect to pay a year's worth of property taxes and insurance. Adding a mortgage payment increases your carrying costs and can add to the challenges of house flipping if it takes longer than expected to sell.
High interest rates
Expect to pay significantly higher interest rates for fix-and-flip loans as compared with purchase mortgages, even when it comes to loans for rental properties. This is especially true if you use a hard money lender. As of late February 2020, the 30-year fixed-rate mortgage average APR is just 3.34% in the United States. Meanwhile, fix-and-flip loans from major lender LendingOne start at an APR of 7.49%, and that's for highly qualified borrowers. Rates go up to 12.9%, depending on the property and borrower.
You'll most likely also pay an origination fee, which typically ranges from 1% to 3% of the loan amount. So, on a $200,000 fix-and-flip loan, this can add $2,000 to $6,000 to your project costs.
The Millionacres bottom line
You can get a loan for flipping houses through a hard money lender or private real estate finance company, but it's important to realize that it's a different type of loan -- and therefore a different lending process -- as compared with getting a loan to buy a home to live in or rent out. By learning the principles in this guide, you'll be in a better position to decide whether a house-flipping loan is right for you, and to know what to expect throughout this real estate investing process.