Flipping an investment property? Here’s what you need to know.
So, you’ve been inspired by Chip and Joanna and have decided to find your very own fixer upper to flip as an investment. You’re not alone. The boom in home makeover shows has inspired a new wave of budding real estate investors to get into the business of flipping houses.
What they don’t show you is what happens behind the scenes. Before the fabulous new granite countertops, shiplap ceilings, or rainfall showerheads, there’s one small detail you can’t overlook – securing the funding to make it all happen. It’s important to take a step back and consider the cost of flipping a home with the purpose of resale in mind. On average, you should expect to add about 20-30% (sometimes more!) to the initial purchase price of the home. Here’s a couple things you need to know about funding your investment before diving headfirst into the world of house flipping.
You probably won’t be able to get a traditional home loan
And that’s okay — you probably won’t want to go through a bank anyway, especially when time is of the essence. Traditional mortgages can take well over a couple of months to close, meaning the prime property you had your eyes on will probably be long gone before you can secure funding.
However, time constraints aside, the biggest issue most flippers face with requesting a traditional mortgage loan from a bank is this; banks usually don’t lend on an investment property whose purchase price or requested mortgage amount is more than the appraised value. This means the amount of money you’d need to “fix” your investment property wouldn’t be covered, which defeats the point.
More problems arise if you’re a novice flipper. Banks are looking for very strong credit and want proof (think W-2s and pay stubs) that you’re good for the money they’re lending you. But don’t be discouraged! The majority of fix and flip/rehab loans are funded by private loaners, often by way of hard money loans. Which brings us to our next point…
Hard money loans are your best bet
Hard money loans (also known as rehab loans or “fix and flip” loans) are short-term, interest-only loans. While traditional lenders (read: banks) are looking for strong credit scores, income availability, and overall debt to income ratio, hard money lenders have a different approach: collateral-based lending.
Unlike traditional mortgage loans, these types of loans come from private lenders who take into consideration the “big picture”—the property’s purchase price, the scope and price of the work that needs to be done, and the projected resale value of your property post-flip. It also means if something goes wrong and you’re not able to repay the loan, the lender can take the property as collateral and make their money back.
Another key differentiator is that rehab/fix and flip loans typically don’t have early repayment penalties, meaning you don’t have to worry about getting dinged by a lender should you be able to pay off your loan in advance.