Flipping houses looks like so much fun on HGTV, and it seems so attainable... until you start to think about financing. Sure, flipping is a lucrative business, but it also comes with great risk. Although it may take some creative number crunching (unless you have a giant pile of cash lying around), you have some good options when it comes to financing your first flip.
Here’s an overview to get you started...
Hard Money Loans
Hard money loans, also called "bridge" or "rehab" loans, are offered largely by regional or local non- institutional lenders who know their local market well, and in most cases, evaluate the property as their sole form of recourse, or repayment. That’s right, they generally aren’t probing for all of your personal financial history and credit reports to qualify the loan. Best of all, these short-term loans are generally the only non-recourse loan options available to residential fix & flip borrowers, seriously mitigating their downside risk in the event of a default or market correction. Non-recourse means no personal guarantees; thus, if you default or are even foreclosed on, there is no negative reporting to the credit bureaus, and no deficiency judgments can be pursued even if the lender isn’t made whole after a foreclosure.
In Arizona, annualized hard money rates typically range from 12% to 18% without origination fees charged, or lower with origination fees. However, assuming even a 14% annualized rate of interest would only cost the borrower 1.16% interest per month for the principal funds actually borrowed until paid-off. While the annualized interest on a hard money loan may be high, you’ll likely have your loan in 2 to 7 days, without all the red tape of a traditional lender, no personal guarantees, no pre-payment penalties, and if the loan is paid off in 3 to 6 months (as most successful fix and flips are), you may only pay 3.5% to 7% actual interest on the principal balance borrowed. For example, assuming a $100,000 loan balance at 14%/yr interest rate, your actual interest payments would be $1,166.66/mo (1.16%); or $3,500 (3.5%) for 3 months; or $7,000 (7%) for 6 months, and so on.
Also, be mindful that the high annualized interest rate adds up quickly if held long-term. Hard money loans are commonly referred to as bridge loans because they bridge the short-term need for capital until a property can either be sold or refinanced into long-term conventional financing. Always have your exit strategies in mind and accurate timetables worked out before utilizing a bridge loan.
This kind of loan is most popular with flippers because the lenders expect the property to be in disrepair needing improvements, and they generally do not require 3rd party appraisals, can make immediate lending decisions without bureaucratic loan committees, and can close quickly, all things traditional lenders cannot achieve.
You can begin your search for hard money lenders online, but beware the hard pitch and possible hidden fees. Many web-based businesses are geared toward flippers, but not all of them have your best interests in mind. Another option is to ask local real estate professionals, investment groups, or other contacts.
A private lender generally refers to an individual — think friends and family. As the old adage goes, it’s risky to borrow money from family, but if the paperwork is executed properly (get a lawyer), you’ll both have confidence in an eventual win-win.
Private lenders usually offer slightly better rates than hard money lenders but often require an assignment of the deed in the event of default, or may require title held in their name until payoff. They may also be more open to negotiating payment terms and might even invest for a share of the eventual profits.
When looking for private money lenders, think about wealthy friends and family who might have the available capital to invest. You may also find private lenders through referrals or acquaintances. Be advised that these private lenders should be accredited investors if they are strictly passive. Borrowing from non-accredited or unsophisticated investors can have severe consequences to the borrower in the event of a default or may even constitute an SEC violation in some cases (again, get a lawyer).
Crowdfunding is coordinated by an online web site set up to allow individuals and institutions to collectively lend you money in exchange for either a share of the profit or a preferred return similar to
hard money loans. This can be a somewhat expensive option, but you can generally find a loan
regardless of your financial profile; the focus is on the collateral, the quality of the deal itself, and of
course, your personal experience. There’s probably no negotiating, however, so be sure the deal benefits you as much as it does those who lend and the crowdfunding platform itself. Also, these loans generally require personal guarantees from the borrower on top of high upfront fees, appraisals, and 2-4 week funding periods.
To find crowdfunding options, look for a website that specializes in financing, as typical sites have a minimum cap on how much money you can ask for.
Traditional Bank Financing
Traditional bank financing is probably your worst option for fix-and-flipping homes. Although, traditional non-owner occupied mortgages will probably offer the lowest long-term interest rates as they are set up for terms of up to 30 years. The paperwork is just what you’d expect as well; required 2-3 years tax returns, pay-stubs, bank accounts, disclosures, and an in-depth analysis of your personal financial profile are all part of the process. Traditional lenders also typically have restrictions on the condition of the property you’re looking to buy and limitations of how many properties you can own with federally-backed mortgages.
If you have greater than 20% equity in your home, you can likely avoid some of these use restrictions by taking out a home equity loan or line of credit on your current primary residence. Be careful, though: your own house is the collateral for this loan, and if your investment takes a tumble, the bank could foreclose, ruin your credit, and possibly pursue a deficiency judgment, as these are full-recourse loans.
Just as the name implies, you’ll find traditional financing in traditional places, like banks and credit
unions. You can find many traditional financing options online as well.
Tips for Financing the Flip
This article was featured in the Arizona Journal of Real Estate and Business, June issue.
Michael Bennett started B.E. Lending in 2015, bringing over 13 years of fund management, lending, and real estate sales experience to the company. He is a graduate of ASU's W.P. Carey School of Business and a member of Camelback Society.
Bennett Capital, LLC, DBA B.E. Lending (NMLS ID 1359227). 1 North 1st Street, Suite 755, Phoenix, AZ 85004. Arizona Mortgage Broker License MB #0930346. B.E. Lending only lends for business purposes. B.E. Lending is either licensed or exempt from licensing requirements of all states in which it operates. Your specific facts and circumstances will determine whether B.E. Lending has the authority to approve loans in your specific jurisdiction. Consistent with Federal Fair Lending Laws, B.E. Lending does not discriminate based on race, color, religion, national origin, sex, age, handicap, marital status, familial status or because all or part of your income may be derived from any public assistance program.