If you’re wondering how to finance a house flip, you’re not alone. Buying, renovating, then quickly reselling houses for profit can be a highly lucrative endeavor, yet finding a loan to fund such a project isn’t anything like getting a conventional loan for a home you intend to actually live in.
In fact, there are six types of “fix-and-flip loans” you can use to buy and renovate distressed properties, and each comes with its own set of qualification requirements and pros and cons. Here’s a look at five options and how to figure out which one’s best for you.
1. Hard-money loan
Hard-money loans, sometimes called “rehab loans,” are short-term loans intended for real estate investments. Unlike traditional bank loans, these are issued by private lenders. A hard-money lender can be an individual, a group of investors, or a licensed mortgage broker who uses personal funds to extend the cash.
Hard-money loan terms are usually much shorter than traditional mortgages. Six months to one year is most common, but they can go up to five years. Interest rates are considerably higher, typically ranging from 12% to 21%. Most hard-money lenders also charge 3 to 6 points upfront, where 1 point equals 1% of the loan.
Down payment requirements for hard-money loans are also different. You can expect to receive about 60% to 75% of the property value you intend to purchase. If you’re looking at a $200,000 property, for example, the most you’ll probably be allowed to borrow would be $150,000, meaning you’d have to pay $50,000 upfront.
However, hard-money lenders are generally more willing to accommodate people with lower credit scores (as low as 550). And there’s much less paperwork than a traditional loan, so the process is faster—sometimes as fast as one week. Because the home being purchased is serving as collateral, hard-money loans are best suited for people who have flipped at least two to three homes.
2. Cash-out refinance
If the value of your primary residence has increased, one financing option for your flip is a cash-out refinance. This lets you tap the equity in your home by refinancing your mortgage for more than you currently owe and taking the difference in cash.
As the name suggests, you are in effect “cashing out” some of the equity in your home to pay for something else. Your new loan will be the amount you still owe on your mortgage plus the cash you wanted to take out. So, say you had a $300,000 loan, on which you still owed $200,000. That would mean you had $100,000 in equity in your house. You could cash out $25,000 of that equity, and get a new mortgage for $225,000, to replace your existing $200,000 loan—and then put that $25,000 toward your house flip.
To qualify for most cash-out refinance loans, you need a minimum 640 credit score, a maximum 45% debt-to-income ratio, and at least 30% to 40% of equity in your existing home. But because it’s part of a mortgage, you will typically get a better interest rate than if you were to use a credit card or hard-money loan to fund the same purchase.
There are a couple of caveats. You’ll have to pay closing costs, which average about 3% to 6% of the total loan. And, if you’re refinancing to a higher mortgage rate, you could wind up paying more money in interest on your loan over the long run.
3. Home equity loan or line of credit
If you’ve built equity in your primary residence, you could tap a percentage of it using a home equity loan or home equity line of credit. Both financing options let you borrow money using the equity in your home as collateral. The big difference is a home equity loan provides you with the cash upfront, and you pay monthly installments over the length of the loan (like you do on your first mortgage). With a HELOC, you access the money in small chunks over the life of the loan.
Since you’re getting all the cash upfront, a home equity loan is generally a better financing option when buying and flipping a house. Plus, the interest rate is fixed and fairly low compared with hard-money loans or credit cards, hoveringly currently around 6%—and any interest you pay on the loan is tax-deductible within certain limits.
4. Investment line of credit
An investment line of credit, also called an “acquisition line of credit,” is similar to an HELOC—except it’s issued solely for buying investment properties. This short-term financing option—with loans generally lasting from about 18 to 24 months—lets you borrow cash as needed, up to a predetermined loan limit.
These loans are best suited for people who have experience flipping houses, since borrowers are underwritten and approved based on their demonstrated record of owning or flipping investment properties, and their financial wherewithal. (Read: If you’re a high net worth investor, or own a portfolio of properties totaling over $1 million in value, an investment line of credit might be your best financing option for a single-home or multihome flip.)
Another source of capital for house flippers is crowdfunding, or “peer-to-peer lending,” where the funds are raised through the contributions of a large number of people, usually through the internet.
“The biggest benefit we offer is flexibility and a national focus,” says Nav Athwal, chief executive officer of RealtyShares, a San Francisco–based company that finances investment properties in 35 states. With RealtyShares, funds come from more than 38,000 high net worth individuals who invest in a specific transaction for as little as $5,000.
There’s not a ton of data about crowdfunded investment loans, but RealtyShares funds up to 70% of the estimated after-repair value of a property in as little as 10 days. Interest rates vary from 8% to 11%, with the average loan term on luxury flips being 12 months. The company also does preferred-equity deals, where it takes a partnership interest in the property and benefits from both the interest paid and the potential upside of the transaction.
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