Loan Options To Start House Flipping
Flipping houses involves buying homes with the intention of later reselling them for a profit. Although this can be a lucrative investing strategy, the home renovations that are usually done to increase the value of the properties can be quite expensive. Moreover, traditional financing options aren’t always available.
This post will go over some of the major costs associated with house flipping as well as some of the loans for flipping houses and how to get approved for one. Then we’ll get into what people new to house flipping need to know to get financing.
How Much Does It Cost To Flip A House?
The first thing you need to know if you’re new to the space and looking into flipping a house is that it can be quite expensive. This makes the endeavor not for the faint of heart. The costs break down into several categories:
- Down payment: Whether you get a traditional mortgage loan or other source of financing, the down payment will be one of the biggest costs. Depending on the type of loan you get, a traditional mortgage loan might come with a down payment of as low as 3% – 3.5%. However, if you have to turn to other sources of funding, the down payment may be significantly higher.
- Buying with cash: Sellers will jump at a cash offer if it’s remotely competitive with other bids because there are less hoops to jump through in order for the transaction to close than there would be with a mortgage. In a scenario where you have multiple bidders, this can be the way to go, but it means having access to significant upfront capital, which may be a challenge.
- Cost of financing: With interest rates being as low as they are now, it’s not unreasonable to assume that a well-qualified borrower looking to get a traditional mortgage might receive something in the range of 3% or lower, depending on the term. On the other hand, hard money loans that are common for house flipping can be easily 10% or higher.
- Homeowners insurance: You may only own the house for a short period of time, but you’ll still need a homeowners insurance policy to protect your investment until you can sell it. It will probably even be required by a lender if the house is being used as collateral.
- Real estate taxes: Property taxes and real estate transfer taxes also need to be factored in your equation. The government is going to get its bite at the apple.
- Marketing: When it comes time to sell, you’ll either have to foot the bill to market the property on your own or pay a real estate agent a commission that’s usually around 6%. This could eat into your profit margin.
- The cost of renovations: The last big thing to consider is the cost of the renovations themselves. What you do factors in as much as anything else in the cost of the flip. Redoing the kitchen might end up being a lot less expensive than adding on an entire wing of the house, for example.
One estimate places the overall cost of flipping a home at 10% of the home’s purchase price. However, these vary widely depending on what you’re trying to do. Some other investors believe you should leave wiggle room in the budget by never paying more than 70% of the after-repair value of the property. Meanwhile, others take that a step further by backing out the estimated cost of renovations.
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Best Loans For Flipping Houses
Unless you hit the lottery and are now independently wealthy, odds are good that you need to find sources of financing for your house flipping projects. Here are some of the most common types of loans used.
Hard Money Loans
One common type of loan used in house flipping is a hard money loan. A hard money loan can be easier to qualify for because the lender isn’t looking at your credit necessarily. They may pull it to get a look at your debt-do-income ratio (DTI), but they’re not looking at the score itself. The amount of equity you have in the home is also important so a higher down payment may be required.
Because there’s not as much underwriting taking place, the approval time for a hard money loan may be much faster and you may be able to get one with dings on your credit. However, the downside is that origination fees and interest rates may be much higher than with a more traditional mortgage.
Traditional Mortgage Loans
There are several types of traditional mortgage loans you might take advantage of depending on the level of flipping you want to do. Let’s run through a few of these:
- Construction loans: If you’re a builder looking to build a house from the ground up, you would do so with a construction loan, paying the loan off and moving on when the house is sold. If you stay in the house after renovating, the loan would need to be converted into a traditional mortgage. Rocket Mortgage® doesn’t offer construction loans at this time.
- Renovation loans: Renovation loans have traditional mortgage rates and appraisals. These are for when you’re doing home improvements on a completed house. The renovation cost is built into the loan because it’s appraised based on the after-repair value (ARV). Rocket Mortgage® isn’t offering renovation loans currently.
- Cash-out refinance: With a cash-out refinance, you take existing equity out of another home you have in order to use that equity to invest in the home being flipped. This may be one of the cheapest financing options because it’s based on an existing primary lien. Because the house is already complete, there is less risk for lenders.
Loans from private lenders may be a good option, but they also often require existing banking relationships. Banks will consider you less of a risk the longer the history you have with them and may even factor in the amount of money you have under their care.
The advantage of going with a private lender is that they may have more options for financing terms.
A personal loan has the advantage that there’s no collateral involved. You can also quickly determine whether you qualify and get your money in as little as a day or so. The only downside here is that the interest rate is higher than it might be for a mortgage.
If you’re interested in a personal loan, our friends at Rocket Loans® offer them in amounts between $2,000 – $45,000.1 The terms are 36 or 60 months.
Home Equity Loan
A home equity loan is for those who want to make use of the equity they currently have in their home to invest in a property flip, but who don’t want to touch their primary mortgage because they like the terms of their current loan. It’s a second mortgage with a separate monthly payment.
The potential downside of home equity loans is that rates tend to be higher than primary mortgages because the primary mortgage lender gets payback preference in the event that you default. For this reason, it’s important to do the math and determine whether this is cost-effective for you.
Home Equity Line Of Credit (HELOC)
HELOCs are like credit cards, but with your home used as collateral. You get a revolving credit line based on the equity in your existing home. There are two phases: a draw period and a repayment period.
The draw period might last up to 10 years, for example. During this time frame, you only pay interest on the portion of the line of credit that you’re using at any given time. You can also pay back into the HELOC so that you have more to draw out later for your next project.
During the repayment period, which might be as much as 20 years, your loan will fully amortize so that you’re paying both principal and interest back. During the repayment period, you can no longer draw on the line of credit.
Bridge loans are short-term loans made to serve as a stopgap between the time you need funding and when you can actually secure longer-term financing. They are typically made at higher interest rates, but you can get funding more quickly while waiting to get the money from something like a mortgage. The proceeds from the mortgage are then used to pay off the bridge loan.
The risk with bridge loans comes if you’re longer-term financing falls through. If that happens, you’re stuck paying a short-term loan at a higher interest rate.
Crowdfunding your property-flipping venture has a couple of advantages: You don’t have to fund the whole thing yourself, but you also don’t have to qualify for a loan. You can also fund your project fairly quickly if enough investors jump on board with what you’re trying to do.
It’s not for everyone, though, as there are several downsides. For starters, you have to market your project. You need to pitch your business plan and be prepared for plenty of people not to take you up on your offer. Additionally, you might get a smaller percentage of profit because the crowd funders are entitled to their share under your arrangement. Finally, if you fail, you have to deal with a lot of unhappy investors who can disparage you and make moving on difficult.
How To Get A Loan For Flipping Houses
Whether you’re getting a loan from a more traditional lending source or from a hard money lender, there are a few things that are going to be unique to getting a loan for flipping a house. Let’s run through this:
- Have your blueprints ready: Because the purpose of the loan is to renovate the home, you’ll want to have your blueprints ready and have estimates from contractors and anyone else you’re working with on exactly how much this going to cost. The lender will be very interested in the ARV. This is because you’re paying off the loan with the proceeds from the sale of the house after the repair or renovations. The loan will be based on the new value which is only determinable on paper in the beginning.
- Know the market: An appraiser will assign a value to your home after renovations based on properties that have features that the newly renovated property will have. Analyze recent sales to avoid surprises.
- Loan-to-value ratio (LTV): LTV compares the amount of the loan to the overall value of the property. In this case, it would typically be used in the equation to help decide what your mortgage rate would be on any financing used to purchase the house initially. If everything else is held equal, your rate will be lower as you have a bigger down payment because the lender doesn’t have to risk as much.
Loan-to-cost ratio (LTC): LTC is like LTV but it’s typically used for commercial loans. This is preferred by some lenders depending on the type of construction you’re doing.
Can Inexperienced Flippers Qualify For House Flipping Loans?
Inexperienced flippers are going to find it more difficult to be approved for house-flipping loans. Lending is a risk-based calculation. If you don’t have a ton of experience flipping homes, there’s more of a chance the project spirals out of control and you end up defaulting.
When new house flippers are starting out, they should make sure they know the market, have their project plan and business case outlined with blueprints and that they have access to some capital. There’s a good chance you’ll have to make higher down payments and pay higher interest rates. You might have to start by working with hard money lenders rather than more traditional and consumer-friendly forms of financing when you’re first starting out. It’s not a business to be taken lightly.
The Bottom Line
House flipping is the process of repairing and renovating homes for profit. There are several costs involved, including not only acquiring the property and renovations, but also marketing, insurance and taxes.
Traditional mortgages offer some of the lowest rates, but they can be more difficult and time-consuming to qualify for. Hard money lenders don’t care so much about your credit, but they’ll charge you higher interest rates. Other funding options include personal and bridge loans as well as home equity loans and HELOCs.
If you’re looking to start house flipping, it’s important to have a plan and know the market. It also helps to have some funds of your own available to make you less risky to lenders. While it can be a lucrative investment opportunity, it’s not for everyone.
Are you looking to buy a flip? Apply today!
1 Rocket Mortgage® and RockLoans Marketplace LLC (doing business as Rocket Loans®) are separate operating subsidiaries of Rocket Companies, Inc. (NYSE: RKT). Each company is a separate legal entity operated and managed through its own management and governance structure as required by its state of incorporation, and applicable legal and regulatory requirements.