To flip a property is to buy a run-down property, remodel it, and sell it for profit. But how does a fix-and-flip loan work? Fix-and-flip loans are short-term credit from private investors or hard money lenders (instead of banks or credit unions) to real estate investors, enabling them to flip a property.
A traditional home loan is a long-term investment if you want to buy and own property for years or decades. What makes a fix-and-flip loan different from conventional loans is that its target is the fast-moving real estate world.
House-flipping has become popular over the years, but a lack of ready and sustainable cash keeps people from mining this opportunity. So, this loan comes in to fill the gap, and unlike a traditional loan, the property you want to buy stands as collateral, and the lender does not focus on your credit or income as much.
Let’s say you find a distressed house at an auction and need to pay cash within a couple of weeks; getting approved for a fix-and-flip loan in time to pay for the property is more accessible than applying for a standard loan with a bank.
Before giving out money to flip property, lenders will consider the property’s purchase price and the after-repair value (ARV), which is the property’s worth after repairs are complete. The lender would typically send an appraiser to value the property and ensure it’s worth the risk before committing to financing its renovation.
These loans are very profitable, and in the second quarter of 2021, investors flipped more than 80,000 homes and condos in America, coming second to the 83,000 flips of 2006. People who get a fix-and-flip loan usually use it in any of the following ways:
A fix-and-flip loan allows you to buy a property and put it back on the market. Ideally, you’ll want to find a distressed property at a discount in a nice neighborhood where the chances of making good returns are higher.
The purchase is straightforward; first, you apply to your chosen lender with supporting documents and an appraisal. You may also submit a plan for the property detailing the proposed renovation process and estimated expenses. Once approved, you can close on the property and begin the next phase.
Fix-and-flip loans allow reserve funds to renovate the property after purchase, making them appealing to prospective buyers. The renovation process is where things get interesting because what you do at this point may determine how fast the house gets sold.
So, you want to add modern fittings, replace floor tiles, repaint, install new kitchen cabinets, fit new appliances, and more to make the house more appealing to prospective buyers. Take note that this is a capital-intensive project, and without accurate estimates on renovation, your project can go over budget, cutting into your profit (check out our online Tools application which can help track and manage your real estate projects).
Rather than buy an old property, you can also start from scratch, buying a dilapidated property, demolishing it, and building a new house on vacant land. However, some lenders may insist on a construction holdback, meaning you don’t get the money until work on the property starts. You may consider how quickly a lender will release funds before committing to a loan.
The capital inefficiencies in the lending marketplace drive the demand for fix-and-flip loans, and these loans create an investment opportunity and can yield attractive returns for investors. In 2017 alone, house flipping attracted an estimated gross profit of $83,131 per flipped property. Some benefits of fix-and-flip loans are:
You may wait months for approval with traditional home loans, but a fix-and-flip loan may allow you access to funds in a week. In order to make a winning bid on a foreclosed or auctioned property, you need ready cash, and a fix-and-flip loan gets you that, with fewer procedures and bottlenecks.
Hard money lenders who offer financing solutions like the fix-and-flip loan are not tied to rigid procedures and requirements like traditional banks. Even when you don’t qualify for other lending opportunities, you can usually trust this loan to come through. As long as you present a realistic plan to repay the loan, your chances of getting funded are higher and more predictable than bank loans.
Approval for a regular loan hangs on your credit, income, and mortgage, but fix-and-flip loans are typically easier to access with fewer requirements. The real estate in question, whether land or property, stands as security if you default, so the lender can repossess it and work with another flipper to put it back on the market. Alternatively, they can turn it into a rental, adding the property to their portfolio.
When you take out a bank loan, you are not allowed to pay it back before it matures; otherwise, you will pay a fine. Fix-and-flip loans do away with these penalties since they are short-term loans, allowing you to pay off the loan and keep your profit after selling the property.
Flipping an old or distressed property sounds very lucrative, but it costs more than buying a habitable house because you need money to buy the property and upgrade it. Apart from construction and renovation costs, flipping a property attracts other hidden fees. Since every property is different, the costs you will encounter may vary, but here are a few to keep in mind:
Having an estimate of these costs in mind will help with your fix-and-flip loan application. Presenting an inaccurate amount can slow down the loan process or incur unnecessary debts for you. So, crunch those numbers before sending your application.
If you want to flip a property but don’t have the money or are unwilling to take the risk with your own money, various options are available. Consider private lenders, hard money lenders, or real estate crowdfunding sites for help with funding.
One place to find lenders is online, but ensure you do your due diligence before committing, as each lender has different fees and interest rates. Speak to other flippers and ask about their experience with lenders, their pricing, how responsive the lender is, and more. You can even ask for references and put calls through.
Working with an unreliable lender can make your deal fall through. For example, if the lender does not provide the agreed funding at the required time, you may lose your deposit on the property.
That is why you need to understand the terms of your loan, and if necessary, hire a financial or legal professional to review the terms of the agreement, to ensure you know what you are signing up for.
At any stage in your real estate journey, capital does not have to be an issue, and with fix-and-flip loans becoming a popular option, your options for fast, reliable, and sustainable financing are wider than ever. Learning how these loans works will prepare you to seize real estate opportunities as they arise.
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