House flipping is at its highest level since 2007, thanks to rising home prices and the increased availability of financing. What’s more, a limited housing supply is helping flippers earn higher profits now than they were getting after the 2008-9 housing crisis, when foreclosures flooded the real estate market.
While buying, fixing and quickly reselling properties can be lucrative, it takes much more money to flip a house than it does to simply buy a house that you want to live in. Not only do you need the money to become the property’s owner, but you also need renovation funds, plus the means to cover property taxes, utilities and homeowners' insurance from the day the sale closes through the rehab work and until the day it sells. Short-term capital gains tax rates of 10% to 37%, depending on your federal income tax bracket, will cut into any profits you earn on properties you flip within one year or less.
If you have no cash of your own to invest, getting started in house-flipping is not an easy proposition. This isn’t 2005 when anyone who could fog a mirror could get a mortgage with nothing down. Even if you qualify for a loan with a down payment, you’ll pay more when you’re borrowing to finance a flip than when you’re borrowing to buy a primary residence: Lenders see flipping as a riskier proposition.
Further, many lenders will not work with inexperienced flippers. They will want to see that you have a successful track record of selling at least one home for a profit. Others will work with an inexperienced flipper, but will charge higher fees and interest.
If you’re interested in flipping homes but aren’t an all-cash buyer, here are some options for financing the endeavor.
Hard Money Loans
Experts disagree on what how “hard money” got its name. Some say it refers to the fact that it is much more expensive than traditional financing and has “harder” terms. Others say it’s because it finances houses that are “hard” for conventional lenders to finance. Still others say the term describes the collateral for the loan: a hard asset, which in this case is the real estate.
Whatever the term's origins, hard money loans usually have terms of less than one year and interest rates of 12% to 18%, plus two to five points. A point is equal to 1% of the loan amount, so if you were borrowing $112,000 and the lender charged two points, you would pay 2% of $112,000, or $2,240. Rather than pay points at closing, as you would with a conventional mortgage, with a hard money loan you may not have to pay points until the home sells – the one soft thing about this hard money.
Hard money lenders base the amount you can borrow on the home’s after-renovation value (ARV). If a home costs $80,000 but the ARV is $160,000 and you can borrow up to 70% of ARV, then you can borrow $112,000. After paying the $80,000 purchase price, you’ll have $32,000 left for closing costs (though you might be able to negotiate for the home's seller to pay them), lender fees, rehab, carrying costs and selling expenses such as staging, marketing and real estate agent commissions. If you can stick to that budget, you won’t need any money out of pocket to flip the home.
The $2,240 in points will take up a significant chunk of that $32,000 budget, though, and if you’re paying 15% interest for six months, your total interest cost on $112,000 will be $8,400. Hard money lenders typically expect interest-only payments monthly while the loan is outstanding, but some may allow the interest to accrue and not require it to be paid until the flip is complete. After these two big expenses, you’ll have just $21,360 for everything else – less if you had to pay closing costs. But if the home really does sell for $160,000, you’re looking at a $48,000 profit, minus taxes, for six months of work, potentially without writing a single check from your own bank account.
Hard Money vs. Conventional Loans
Lucas Machado, president of House Heroes, a group of real estate investors that flips South Florida houses and finances hard money loans, says hard money loans are easy in another way: The lack of bureaucratic red tape. Unlike conventional banks, lenders aren’t bound by guidelines regarding the shape of the real estate. “Properties in poor condition don’t satisfy guidelines for traditional mortgage financing. Hard money lenders, on the other hand, expect to lend on houses in disrepair,” Machado says.
Rather, “hard money lenders decide whether to make the loan by evaluating the strength of the deal and the reliability of the home flipper,” Machado says. If the purchase and repair cost vs. the resale value makes sense and the home flipper is trustworthy, a hard money lender will make the loan.
In evaluating the flipper, hard money lenders aren't usually worried by borrower qualifications such as debt-to-income ratios and credit scores. In some cases, they may want to see an applicant's documents such as tax returns, bank statements and credit reports. Nor do they care if down payment funds are borrowed (another difference to conventional lenders). After all, “Should the flipper default, the hard money lender can foreclose, take ownership of the house and sell it profitably on their own,” Machado notes.
A hard money lender, similar to a bank, will hold the first position lien on the home until the borrower repays the loan, but the borrower will be the owner and will hold the deed, explains Mat Trenchard, acquisitions manager with Senna House Buyers, one of the largest house-buying companies in Houston.
Where to Look for Lenders
One place to find a hard money lender is online.
Lima One Capital will work with new flippers and will lend up to 90% of loan-to-cost or up to 75% of loan-to-ARV. Fees and interest rates decrease with a borrower’s flipping experience. Lima One lends in most states; rates and fees vary by state. In general, expect to pay an origination fee of 3.5% and an interest rate of 12% if you’ve completed up to one flip in the last 24 months; a 3% origination fee and an 11% interest rate with two to four flips under your belt; and an origination fee of 2% and an interest rate of 9.99% with five or more completed flips. Borrowers with credit scores lower than 680 will be able to borrow slightly less and will pay the highest costs; the minimum credit score is 630. Lima One Capital requires a 10% down payment and offers repayment terms up to 13 months.
LendingHome offers fix-and-flip loans for up to 90% of the purchase price and 100% of renovation costs. Borrowers must submit bank statements to show they can cover the down payment and closing costs; a purchase contract; a list of their past fix-and-flip projects; property documentation; and a down payment. Interest rates typically range from 7.5% to 12%. There is a $199 application fee to cover third-party loan underwriting costs. LendingHome also charges an origination fee, appraisal fee, and title and escrow fees, and the company holds back rehab funds until after the renovations are complete.
As another option, Machado suggests reaching out to local real estate investment associations, local investors and local real estate agents to find brick-and-mortar hard money lenders. But there may not be much room to negotiate, especially on points and interest rates.
Over the past few years, Machado notes, there have been so many opportunities to lend money that there is no need to chase a deal. “Why take on a loan at a lower return today, when you'll probably come across another opportunity tomorrow?” he asks.
“A private lender is simply an individual with substantial capital to loan you,” says Trenchard. “You would be surprised how many individuals are out there looking to loan money they have saved. They will operate much like an HML [hard money lender], except typically you can get better rates and terms.”
Trenchard says private lenders may be more open to negotiating payment terms than hard money lenders are. They may even be willing to act as a partner on the deal and take a share of the profits in exchange for not charging interest.
“The key for the inexperienced flipper is to have confidence when negotiating,” Trenchard says. “They need to network and talk to other flippers about how much they are used to paying and know they can walk away. Don’t think because you couldn't come to an agreement with the first lender you talk to that you won't find the money for a deal.”
You can seek out private lenders at local real estate networking events. These individuals might charge 8% to 12%, plus zero to two points compared to a hard money lender’s 12% to 15% with two to five points, Trenchard says. Like a hard money lender or a bank, they will take a first position lien on the house.
How to Vet a Private Lender
Experienced professional flippers say that the best way to vet a private lender you’re considering working with is to speak with other flippers – whom you’ll also find at real estate networking events – and ask if they have experience with those lenders. How quick was the turnaround? What pricing did they receive? How responsive was the lender? You can also ask for references and call them.
The worst-case scenario is usually that a deal falls through because the lender doesn’t provide the promised funding and the buyer loses his or her earnest money deposit. Another possibility is being surprised at the settlement table by unexpected lender fees. There is also the potential for legal battles over contract terms or a lender trying to catch a borrower in default so he can foreclose on the property. These are all good reasons to check out a lender before signing anything.
“That said, remember that in this kind of transaction, the lender is trading a bunch of money in exchange for some signed sheets of paper – loan documents. That’s not a bad deal for the borrower,” Machado says.
Online Private Lenders
Technically, a private lender is a friend, family member or another individual who doesn’t make a business out of lending money but agrees to give you financing, says Brian Davis, co-founder of SparkRental and a real estate investor with 15 properties. Some companies may call themselves private lenders simply because they are privately owned. Like hard money lenders, you can also find them on the internet.
5 Arch Funding, based in Irvine, Calif., works with experienced flippers in 30 states. It offers single-digit interest rates for fix-and-flip loans.
Anchor Loans claims it is the nation’s largest fix-and-flip lender. The Calabasas, Calif.–based company can close deals within seven days on a wide array of property types at competitive interest rates in 46 states. Terms vary by state; in California, for example, loans are available with interest rates of 8% to 12%, depending on loan-to-value and borrower experience, with origination fees of 2% to 3% and loan terms of six to 12 months with no prepayment penalties. Flippers can borrow up to 70% of the home’s ARV. Borrowers must have a proven track record of at least five flips in the previous 18 months; Anchor Loans will consider loans to qualified corporations and multi-member limited liability companies (LLCs) with fewer than five flips.
Crowdfunding relies on a group of various individuals and/or institutions to collectively finance loans. Each lender, who is referred to as an investor, supplies a small percentage of the borrower’s loan and earns interest on that money.
Traditional crowdfunding sites like Prosper aren’t geared toward buying and flipping houses; Prosper’s maximum loan amount of $35,000 is intended for projects like home renovation, debt consolidation and small business funding. That’s where specialty crowdfunding sites for residential real estate flippers come in. Some will “prefund” your loan, meaning that the company will quickly close your loan using its own money while it waits for investors to put up funding, while others do not close your loan until investors have fully funded it. That may mean a slower closing or no closing.
“Crowdfunding websites occupy a similar niche as hard money lenders,” Davis says. “They’re relatively expensive, but will lend to real estate investors regardless of how many mortgages they have, and focus heavily on the collateral and quality of the deal itself.”
Four Crowdfunding Sites
RealtyShares offers short-term rehab loan to cost (LTC) financing of up to 90%, closings in as few as 10 days, terms of 6 to 24 months and rates starting at 9%. Loans of $100,000 to $10 million are available. The company works with experienced investment companies with a proven track record and only approves 5% of deals.
Groundfloor offers loans from $25,000 to $2 million with financing of up to 90% of LTC, closings in as few as seven days, no payments during the loan term, and no tax returns or bank statements required for loans under half a million. Interest rates range from 5.4% to 26%. Borrowers must pay a minimum of three months of interest even if they pay off the loan sooner. Typical closing costs are $500 to $1,500, and Groundfloor charges two to four points per loan. All points and fees can be rolled into the loan. Groundfloor typically does not work with inexperienced flippers.
Patch of Land offers loans from $100,000 to $5 million with financing of up to 80% of loan-to-value or up to 70% of after-renovated value, closings in as few as seven days, and interest rates starting at 7.99%. Borrowers make automatic monthly interest payments on their loans for terms of one to 36 months. Patch of Land only works with experienced developers.
Trenchard and Machado said they had not used any real estate crowdfunding websites. But both suspected that the crowdfunders’ process for evaluating and committing to a deal might be slower than what a borrower would experience with a private or hard money lender. Once a flipper has a solid relationship with a lender, the two might be able to close a deal in 24 hours when a great opportunity comes up and all the paperwork is in order.
Unlike a private lender, crowdfunding sites also may not offer the opportunity to negotiate. They may have set parameters for each deal because they are responsible for a large group of investors.
The Bottom Line
If you don’t have enough cash to flip a house without financial help – or if you do have the cash but want to limit your risk – there are several ways to get funding. A hard money lender, private lender or real estate crowdfunding site can help you achieve your house-flipping dreams.
All of these options are expensive compared with traditional mortgage financing for an owner-occupied home, but their price reflects the high risk the lender is taking and the unlikelihood of your getting a low-interest bank loan to flip a house. But using other people’s money not only lets you get started in the flipping business when you have little or no cash to invest, but it also gives you a chance to flip more properties simultaneously and increase your overall profits once you gain enough experience to do multiple deals.
“If you know the options, where to find them and how to network, the problem lies more in finding deals than in finding the money,” Trenchard says. “It is very easy to find money for a great deal, but it is very difficult to find great deals.”
Disclaimer: The lenders named and described in this article are presented for informational purposes only. Neither Investopedia nor the author endorses any of these companies. Borrowers should do their own research before determining if any of these lenders are a good choice for their particular financing needs.