There are many ways to get financing for your fix-and-flip projects, but the fact of the matter is, no matter what route you take, borrowing money is a partnership. Whether you choose to use a bank, a private loan through a friend or family member, or a hard money loan from a reliable lending resource, it is a relationship that needs to be mutually beneficial—it is a business after all.
Due to this, it is important to have all your ducks in a row in terms of education/research, credit score, the right property to flip, etc. before finding financing, because if a few of these things are not aligned, it could potentially put you in a position to get your loan application denied—setting you a bit behind in your fix-and-flip goals.
Requirements to get a loan can also vary by state, but there are general reasons that it may not go through, as lenders are always prioritizing decreasing risk. Learn more about the various denial reasons for a loan application and ways to avoid it from happening.
5 Reasons Your Loan Application May Be Denied
1. Unsatisfactory credit score
Checking a borrower’s credit score is an industry standard to help decipher if they are a good candidate for a hard money loan. Various lenders may have different standards in regard to the minimum FICO score that they are willing to work with. More often than not, this is a key indicator in understanding the way a potential borrower and/or guarantor uses money. So, if you know or suspect that your score may not be the most desirable, it is a likely reason why your loan application was denied.
Before you apply for a loan, please check to make sure what the minimum credit score is and make sure you exceed that.
In general there are ways individuals can boost their credit score. These include paying off debt, making sure all your bills are paid on time, and disputing inaccuracies found on credit reports.
2. Unsatisfactory background check
Much like your credit score, a background check may be required. Since lender’s are putting a significant amount of money into each and every project, a background check is a way of understanding someone’s history a bit better and having a clearer vision of who they are doing business with. If you have something in your past, such as a bankruptcy or felony on your record, that may be a red flag.
It is best to be up front with your lender about the circumstance. Transparency can go a long way and save you a lot of time and disappointment. It is important to know that certain things might be deal breakers for certain lenders, but like anything, honesty is always the best policy. Lying on your mortgage documents and misrepresenting your background is a crime, and no deal is worth that risk.
3. Valuation of the property is too low
Some deals simply aren’t worth doing. If a lender observes that the return on investment (ROI) may be too low, the loan application could be denied. Lenders want to ensure their time and money are well spent. The after repair value (ARV) should exceed a certain percentage that a borrower determines would be a profitable business deal.
This percentage can be different for different lenders. It is best to have an open conversation and do your research before applying and missing the mark.
You can also consider the three S’s. The three S’s are often referred to when looking at what sort of property fits the bill: safety, security, and soundness. Safety guarantees that the property is a safe and healthy place to reside. Security speaks to the home being secure for the property. Soundness refers to the house; it should be physically sound and without any structural issues.
Sometimes when a house needs too much work in one or more of these areas, the ROI simply isn’t worth the trouble and a lender may opt out of the loan. The trick is to find a happy medium—a property that needs just enough repairs for a positive flip but doesn’t need a full revamp.
4. Property type is not a fit
There are plenty of different properties out there to fix and flip: commercial properties, residential homes, condominiums, and much more. Various properties pose their own benefits and challenges. Some lenders have found from their experience that they only prefer to lend to certain types of properties based on numerous things like renovation projects needed, industry standards, their budget, etc. If you apply for a property they are not willing to support, your loan could be denied.
Be sure to go into the process with knowledge about your lender and the types of properties they usually agree to.
5. Insufficient cash to close funds
Most lenders will ask that you have some “skin in the game,” meaning some of your own money riding on the success of the property you are investing in. It’s a way to solidify a partnership and keep good faith. You will oftentimes have to put down a percentage of the down payment, escrow funds, title insurance, etc. If you cannot provide that, you may not be approved to move forward.
Prior to applying for a loan, it is important to see yourself as an equal partner in this and to also understand the lender’s perspective. This, again, is another area of an application that can vary by lender.
The reality is that when seeking a hard money loan for a fix-and-flip project, different lenders have specific requirements that can vary. There are a multitude of reasons as to why your loan application was denied, but to avoid extra paperwork and disappointment, do your research and understand who you are partnering with. This is an equal relationship after all, and you need to vet them just as much as they vet you. It’s important to remember that in this relationship, a little bit of vetting goes a long way in making sure both lender and borrower make money together.
If your loan gets denied the first time around, do not give up. Ask questions, communicate, and find out what you can do to change the situation. It may take some time to bring up your credit score, find a suitable property, or earn some funds for the loan to close—but patience is a key trait needed to thrive in this industry.
Do not be discouraged based on your experience. There is always a learning curve, and anyone can start in real estate investing with the right research and resources. Many lenders value giving funding to investors who are experienced, as well as those who are just starting out in the industry. Being able to create opportunity and bring more people into the universe of fixing and flipping homes is a fantastic mission to be a part of.
Still confused about why your loan application was denied?
Let’s talk in the comment section below.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.