What are Fix & Flip Loans
Real estate investors use fix and flip loans to buy and improve a property they will quickly sell for profit. How exactly does this real estate investment opportunity work? Learn everything you need to know, including all the pros and cons, about fix and flip loans here.
What are Fix & Flip Loans?
Flipping a property is usually buying a home that needs repair, doing the remodeling work and then reselling it, hopefully for a profit. This method works for other types of property, but homes are the most common. A Fix & Flip loan is a short-term, high-interest loan that covers the cost of buying the property and making the repairs.
With this type of loan, it may be possible to buy “fixer-upper” properties, also called distressed properties. Then you can do renovations with any remaining proceeds from the flip loans to bring each property back up to the standards of the current building codes. Usually, a professional “flipper” will also make aesthetic improvements for fix and flip deals that attract buyers willing to pay premium prices for a home in excellent condition.
One common technique is buying run-down houses in a nice neighborhood and fixing them with fix and flip loans. This technique works reasonably well if the home’s purchase price is no more than 70% of the after-repair value, minus the cost of doing the repairs. You want to have a wide margin of error in your deal to avoid losing money.
Types of Fix & Flip Loans
Professionals already in the construction industry may have access to interim financing that they can use to flip properties. They achieve this financing support from fix and flip lenders by having a long, successful track record of making money for their investors.
Others may secure loans to flip houses by providing additional collateral besides the purchased property. This requirement is typical for fix and flip loans for beginners.
What are fix and flip loans? The types of sources that may work as a loan flip for repairing and flipping a property include:
- Hard Money Loans
- Cash-Out Refinance
- Home Equity Line of Credit (HELOC)
- Seller Financing
- Investment Property Credit Line (based on rental income)
- Bridge Loans
- Business Credit Lines
These short-term loans work until a property sells or a longer-term loan is put in place.
Hard Money Loans
Banks and traditional mortgage lenders rarely do house flipping loans. Instead, financing can come from “hard money” private investors who charge high fees and high interest due to the risk of fix and flip financing. They are called “hard” for being harder to get and harder to pay back than “softer,” more traditional real estate financing.
A common type of hard money loan is one with interest-only payments for a period of up to one year.
A bridge loan is a short-term loan. Bridge loans are also called gap financing. The money you borrow bridges the gap between purchasing a property, doing a renovation project and putting long-term financing in place. A bridge loan may last for a few weeks or up to a few years, depending on the terms.
A homeowner with substantial equity in a property for sale may use a bridge loan to buy another home before selling the first one. Large real estate investors may use bridge loans to close on a property quickly for a good price, knowing they’ll need to replace the financing later.
Costs of Flipping a Property
The costs of flipping a property may be substantial. The discovery of unexpected problems that require expensive repairs is a worst-case scenario that can make a project unprofitable.
Here’s a checklist of some of the costs that investors should be aware of when flipping properties using a fix and flip loan:
- Property Acquisition Costs: These costs include the inspections, good-faith deposits, purchase price, closing costs, attorney’s fees (if needed), financing costs (loan points and fees), trash removal, hazard cleanup and the costs of liens, such as paying off unpaid property taxes to get clear title.
- Renovation and Rehab Costs: These costs include the construction plans, building permits, labor, materials, insurance, bonding, equipment rental and various expenses associated with a major renovation project.
- Loan Carrying Costs: These are loan payments until the property sells.
- Holding Costs: These are the expenses, such as utilities and landscaping, needed to keep the home well-maintained until it sells.
- Selling Costs: The cost of selling the property includes sales commissions, advertising/marketing expenses (if any), building inspections and closing costs.
Advantages of Fix & Flip Loans
There are many advantages to using a Fix & Flip loan. Some can include:
- OPM: OPM is using other people’s money to leverage your return on investment.
- Secured Construction Project Funding: The construction renovation funding is in place before purchasing the property.
- Efficiency: The short-term nature of the financing is constant pressure to get the job done in the most time-efficient ways possible.
- Rewarding Work: It can be rewarding to be your own boss, buy a run-down place, fix it up and then make money selling it.
Disadvantages of Fix & Flip Loans
Many problems come up with flipping properties. Common issues include underestimating the renovation costs, supply chain disruptions, rising material costs, construction labor shortages and real estate market dynamics.
Some disadvantages of a Fix & Flip loan are:
- Collateral Requirements: The loan may require additional collateral besides the purchased property.
- Loan Amount is Too Small: The funds are not sufficient to finish the project, which can cause a financial disaster when you run out of money.
- Time Pressure: The short-term nature of these loans means you have to finish the renovation project quickly and sell the home on time or refinance the deal before the Fix & Flip loan term expires.
- Taxes: Flipping a house after owning it for less than a year creates ordinary income from the profits. For a fast turnaround, you do not get the benefit of the lower capital gains tax rates.
Fix and flip loans are important to understand for investors who are savvy and experienced in the world of real estate flipping. But you want to be careful about getting into this “investment” type without any real experience.
If investing in real estate is something that sounds exciting and fun, you may want to consider alternative real estate investment opportunities like the short-term notes that Connect Invest offers. High-yield, short-term, low-minimum investment costs may sound too good to be true, but with Connect Invest, it can become a reality. Learn more about Short Notes today to get started.