House flipping is a real estate venture that entails purchasing inexpensive homes that often need work, fixing them up, and then selling them for more than you paid. House flipping can be a lucrative business, but it comes with significant financial risk, especially for beginners.
In 2020, home flipping profit margins and sales declined, according to data from March 2021, but given the COVID-19 pandemic, experts say these figures don't come as a surprise to industry experts.
If you are interested in purchasing properties to fix and flip and don't have the cash, you will need a bank loan to help get you started on your real estate endeavor. As of the second quarter of 2021, interest rates on mortgages are historically low, but you will need strong credit to be approved.
- It generally costs more money to flip a house than to buy one as a home.
- Lenders see flipping as a risky proposition and generally won't work with inexperienced flippers.
- Consider vetting private lenders by speaking to other flippers.
- Flippers may try crowdfunding sites to finance their investments.
- If you are trying to save money to buy a fixer-upper to flip, bear in mind, you will need to cover not only the mortgage cost but renovations, taxes, insurance, and utilities, until you sell the home.
The Costs of Flipping Homes
While buying, fixing, and quickly reselling properties can be lucrative, it takes much more money to flip a house than it does to buy a house in which you want to live. Not only do you need the money to become the property owner, but you also need renovation funds and 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.
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 able to 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. That's because 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.
Hard Money Loans
Experts disagree on 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, as in 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 borrow $112,000 and the lender charges 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, you may not have to pay points until the home sells with a hard money loan—the one soft thing about this hard money.
Hard money lenders base the amount you can borrow on the home’s after-repaired value (ARV). If a house costs $80,000, but the ARV is $160,000, and you can borrow up to 70% of ARV, 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. These include items 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. After these two significant expenses, you’ll have just $21,360 for everything else—less if you had to pay closing costs. But if the home 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 bank account.
Most hard money lenders 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. It might be worth asking your lender if you can wait to pay the loan interest until after you sell.
Hard Money vs. Conventional Loans
Lucas Machado, president of House Heroes, a group of real estate investors that flips houses in Florida 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. Still, the borrower will be the owner and 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. For example, Lima One Capital will work with new flippers and lend up to 90% of loan-to-cost or up to 75% loan-to-ARV. Fees and interest rates decrease with a borrower’s flipping experience. Lima One lends in most states with rates and fees varying by state. 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 660. Also, Lima One Capital requires a 10% down payment and offers repayment terms of up to 13 months.
Closing costs will vary depending on the lender. Expect to have origination fees anywhere between 1.5% to 5% (or more) depending on the scope of the project, and an interest rate between 3% and 6.50% and up, depending on your credit score and other factors.
A second example comes from LendingHome. This firm offers fix-and-flip loans for up to 90% of the purchase price and 100% renovation costs. Borrowers must submit bank statements to show they can cover the down payment and closing costs. Other requirements include a purchase contract, a list of past fix-and-flip projects, property documentation, and the down payment.
Interest rates typically range from 3.875% for rental projects and 6.50% for bridge loan projects, according to LendingHome's website. LendingHome states that some loans may close in as few as five days, with no application fees, and depending on the type of loan, closing costs in total may be as low as $1,999 for a bridge loan.
House Heroes president, Lucus 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.
“A private lender is simply an individual with substantial capital to loan you,” says Senna House Buyers Mat 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 agree 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 may 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 the best way to measure a private lender you’re considering is to speak with other flippers—whom you’ll also find during 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.
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.
Anchor Loans, a Calabasas, Calif.–based company, can close deals on a wide array of property types at competitive interest rates in 48 states. Terms vary by state.
According to the company's website, flippers can borrow up to 80% of the cost of the home and will loan between $50,000 to $20 million, and loans may be approved up to 5-10 days. A down payment of at least 10% to 20% of the acquisition cost is required. 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 (LLC) with fewer than five flips.
Crowdfunding relies on a group of various individuals and/or institutions to collectively finance loans. Each lender, 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 $40,000 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 pre-fund your loan, meaning 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.”
Groundfloor offers loans in 31 states from $75,000 to $1 million with the financing of up to 100% of loan-to-cost (depending on experience), closings in up to three weeks, no payments during the loan term, and no tax returns or bank statements required for loans under half a million. Interest rates start at 5.5$ and roll points into closing.
Borrowers must pay a minimum of three months of interest even if they pay off the loan sooner. Typical closing costs are $1,250 plus a $250 closing fee, 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 fix-and-flip loans from $150,000 to over $3 million with the financing of up to 85% of loan-to-value, short closing times, and interest rates starting at 7.0%. Borrowers make automatic monthly interest payments on their loans (depending on the type) for terms of one to 36 months. Patch of Land works with first-time flippers and those with experienced, according to its website.
Fund That Flip offers up to potential investors $100,000 and more in funding, with 100% renovation costs, bridge loans that close in as few as seven days, loan terms from three to 24 months, and rates starting at 8.49%. One caveat: The home cannot be owner-occupied to qualify for the loan.
Trenchard and Machado said they did not use any real estate crowdfunding websites. Still, both suspected that the crowdfunding 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 may 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 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.
“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 the money for a great deal, but it is very difficult to find great deals.”
All of these options are expensive compared with traditional mortgage financing for an owner-occupied home. Still, their price reflects the high risk the lender is taking and the unlikelihood of you 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.
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.