Blame HGTV, the housing market, or recent trends in home design. Home flipping is more popular than ever. An increasing number of real estate investors are buying “fixer-uppers,” just to flip them within a year and make a big profit when they sell.
If you’re considering hopping on the fixer-upper bandwagon, you’re not alone. Over 10 percent of all houses sold in the fourth quarter of 2018 were flips. And at least 200,000 flips were sold in 2017 alone.
So, how are these projects financed?
Before flipping became a huge trend, a majority of buyers were using cash to fund their flips. Now, with more first-time flippers entering the market, a majority of potential flips are financed using different types of loans.
Which route should you choose?
Below, we’ve ranked five ways to finance a flip and/or rehab home, from best to worst:
- Finance with cash
- Reach out to friends, family, or crowdfunders
- Use traditional bank financing
- Apply for an FHA 203(k) loan
- Find private lenders
The best option for your flip may depend on your credit score, flipping history, and any deadlines that you may have set for yourself.
Let’s go over each option in a little more depth.
Top 5 Ways to Finance a Flip
1. Finance the Flip With Cash
If you have the cash, use it before going into debt. A house is only successfully “flipped” if you can sell it for a profit. This might mean waiting things out until the housing market picks up or the area you’re in becomes more competitive.
Flippers in debt are more likely to become impatient and sell for a lower price, defeating the entire purpose of flipping in the first place. Yes, it’s possible to use debt and successfully flip a home. But if you don’t have to, don’t do it.
If you can wait a few months and pull together some cash to buy a fixer-upper, wait. This will give you more control over when you sell and how much profit you make from the flip.
New to flipping? Using cash will help you secure a better loan in the future. Lenders will offer lower origination fees and better interest rates if you have some flips under your belt.
There are also a handful of ways to grab some cash from your current assets. You may increase your debt, but the increases will be smaller than if you applied for a private loan or alternative source of funding.
If you’ve built up equity on your primary residence, it’s possible to finance your flip with cold, hard cash. Cash-out refinancing allows you to take out some of the equity you’ve built up and add that to your existing mortgage. That cash can go toward purchasing or improving another property.
If you are considering a cash-out refinance, check to make sure you meet current standards:
- Credit score of 640
- Maximum 45% DTI
- At least 30% of equity in current property
Be sure to calculate the overall costs of a cash-out refinance, including closing costs and a possible increase in interest as you pay off your first mortgage.
Home Equity Loan or HELOC
While a cash-out refi results in one big loan, homeowners also have the option of getting an additional home equity loan. Home equity loans can also give you a lump sum of cash to purchase a flip.
Interest rates tend to be higher and fixed for a home equity loan, whereas cash-out refis may come with adjustable rates. However, cash-out refis last longer than home equity loans, sometimes extending up to 30 years.
Both options are fairly similar, but it’s important to consider mortgage rates and your long-term plans before applying for a cash-out refi or home equity loan.
Not all flips happen overnight. If you don’t need a lump sum of cash right off the bat, consider taking out a home equity line of credit (HELOC) or investment line of credit to fund your flip.
2. Friends, Family, and Crowdfunding
Getting a loan from family and friends can help you cough up the cash without going through a traditional lender. If not, very distant and new family and friends can help you through crowdfunding.
You don’t have to set up a GoFundMe or a Kickstarter to finance a flip. There are plenty of websites that connect flippers to crowdfunders who are looking to put up some cash for you.
Here are a few suggestions:
- Patch of Land
- Fund That Flip
Each crowdfunding site comes with its own unique set of closing costs, rates, and loan terms. Some sites may also require flippers to have experience before putting their project on the website. Be sure to weigh all of your options before choosing this route.
3. Bank Financing
If you have good credit and a strong history of flipping houses, traditional bank financing may be the way to go. Bank financing is one of the cheapest options for project-specific financing, but it still comes with additional costs.
Look out for loan fees, construction inspection fees, and appraisal fees. Even with these fees, you might be able to score a lower interest rate than with private lenders or crowdfunding options though.
4. FHA 203(k) Loan
In general, FHA loans don’t work with flipping houses. The process takes too long, lenders don’t take the home’s after-repair value into consideration, and you will need to meet high standards to get approved. These loans often fail to cover the cost of the home and the cost of repairs, as well.
There is one option that could work—but it comes with a catch. Flippers can get an FHA 203k loan if they are the primary owner of the home. If you want to live in the home while you flip it, this loan may be able to cover the home purchase and improvements. The project must also be completed within six months.
If you’re interested in this type of loan, reach out to potential contractors. Contractors are paid through an escrow account at the end of the project. Inexperienced contractors, or those who underbid, are rarely a good fit for this type of project.
5. Private Lenders and Hard Money Loans
Investors are more likely to consider alternative forms of financing for their rehab or flipping projects. If you are having trouble getting approved for traditional financing or would prefer an alternative source of funds, consider reaching out to private lenders.
Private lenders don’t require a high credit score, although a high credit score can help to reduce costs in the long run. Flipping history may also influence loan terms. Private loans typically have higher interest rates and fees than banks, but you can get a quicker approval than with traditional financing.
Hard money loans are also an option for flippers. These high-risk, high-interest loans may be easier to get than conventional financing, but they do come with shorter loan terms. Most hard money loans need to be paid off within a year. If you want to wait for the housing market to pick up in the area where you’re flipping, a hard money loan may not be the best choice.
Sort through your options and consider all possibilities before you choose to finance your flip. Don’t stop your planning at financing. Consider asset protection and insurance for the project, as well, to cover all of your bases.
Which financing methods have you used in the past? Which are you considering for your fix and flip project? Why?
Share below in the comment section.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.