House flipping is the most popular investment option for those who want to invest in distressed properties and sell them to earn a higher profit after renovation. Hard money lenders often offer fix and flip loans on distressed properties that can be renovated and sold out to gain a higher profit. These loans are usually short-term and typically close when the property is sold out.
Below we will talk about how to fix and flip loans work.
What are Fix and Flip Loans?
Fix and flip loans are short-term and used by real estate investors to purchase distressed properties, improve them, list them on the market, and sell them to gain a higher profit. Improving the house ranges from a minor renovation to a complete reconstruction. People use a fix and flip loan exclusively for residential property. You can not qualify for a fix and flip loan if you want to use it for commercial property such as renovating a hospital or school.
Individuals or investors frequently buy a home at auction, through foreclosure, or a bank short sale. Then they may try to sell the property as it is, or they may choose to add value to the property by improving it. This is where a fix and the flip loan come into existence. When a buyer wants to upgrade a distressed property by improving them, they can use a fix and flip financing to cover the upfront cost of renovation.
Uses of a fix-and-flip loan
You can use fix and flip financing for different purposes. Generally, investors use a fix and flip loan for a diversified real estate investment project including:
Purchasing a distressed property
When an investor gets the opportunity to purchase a distressed property at a cheaper price, sell them after doing some minor renovation.
Renovating a distressed property
When an investor purchases a distressed house that requires significant renovations, they use to fix and flip financing to renovate it and make them more appealing. This significant renovation may include the installation of new doors and kitchen cabinetry, replacement of furniture and floor tiles, house painting, and many more.
Investors also use fix and flip financing for buying a dilapidated house. They razed it to flatten and construct a new house. Now they sell the newly constructed property at a higher price
How do a fix and flip loan work?
Investors use a fix-and-flip loan to purchase a property with the intent to renovate and resell it to gain a higher profit. You can easily qualify for a fix and flip loan as compared to other types of conventional loans. The lenders are not concerned much about the borrower’s credit history; instead, they are more focused on the collateral. So, even if you have a bad credit history, you can qualify for a fix and flip loan.
Generally, the lender comes up with an appraisal to assess the property’s value to make sure it is worth what the borrower is asking. Once the lender evaluates the value of the property and finds it to be loanable, the lender will transfer the funds in a shorter period. The borrower’s creditworthiness does not matter much here as the lender knows that once the property is sold, the borrower will pay off the loan.
Lenders do not find fix and flip loans riskier as they know they can make money by selling the property if the borrower defaults. The lender has the right to take over the property in case the borrower fails to pay off their debt. Then lenders can sell the property themselves and can earn a higher profit. But from the borrower’s side, fix and flip loans are riskier. If a borrower fails to renovate and sell on time, they will lose their property. Once the borrower sells their flipped property on time, they may make a decent profit even after paying off the loan.
Types of fix-and-flip loans
There are six types of fix and flip financing that investors can use for house flipping:
Hard money fix and flip loan –
Some private investment groups offer hard money fix and flip loans.
A group of individuals or institutions pools their resources to fund a flipping project. Each party in the group is referred to as an investor. All the investors contribute money as much as they can and earn interest on the money that they lend.
Individual lenders –
Technically, a private lender can be your friend, family member, or other individuals who do not lend money to do a business out of it but agrees to finance your project.
Home Equity Lines of Credit (HELOC) –
Traditional lenders offer home equity loans, but they do not have the same flexibility as private lenders.
A cash-out refinance –
A conventional bank may provide you with a cash-out refinance and offer you some extra funds by remortgaging your existing home.
An acquisition line of credit –
This is similar to a HELOC but getting qualified is based on having strong finances and the ability to prove income. It is not a feasible option for those house flippers who are new to the industry.
Some essential things that you must know about the fix and flip loans
House flipping is not just about purchasing, renovating, and selling the property; there is more work to do. Make sure that you make a proper estimate for all the expenses before you approach a hard money lender. To make the property appealing, you have to pay material suppliers, contractors, real estate agents, title fees, and many more. You need to make a solid estimate for all of these costs; otherwise, you will have to cut your profit if the house flipping project goes over budget. Do not forget to consider the carrying costs, including maintaining utilities, property taxes, insurance maintenance, etc. Before you apply for a fix and flip loan, get a solid estimate from your contractors and material suppliers.
Real estate agents can help you sell your property quickly but they charge a commission for selling properties. So do not forget to add their commission to your estimate. You can easily sell your renovated property quickly by using a real estate agent and make a higher return (ROI). You can save the commission by selling your property yourself.
As the fix and flip loans are short-term and interest rates are higher, you need to sell the property as soon as possible. Whatever way you choose to sell the property, keep in mind that you need to sell it quickly.