The Best Way to Get a Loan to Fix and Flip a Property
For many real estate investors, outside funding is an essential part of purchasing investment property. While buying in cash is the simplest, an outright cash purchase may not be possible or even preferable, particularly for those who have liquid assets tied up in other investments or who wish to leverage their cash across many properties. Even investors who generally prefer buying in cash may find loans to be necessary from time to time, if, for example, a prior fix and flip is not completed or does not sell as quickly as anticipated, or the investor is maintaining cash levels as a safety net.
Due to the differences between buying investment property and purchasing a personal residence, getting a loan is not always as simple as going to the bank and applying for a mortgage. Here is what you need to know about obtaining a loan to fix and flip an investment property.
Understanding the Math of Flipping an Investment Property for a Profit
Unlike buying a personal residence, in which the purchase price is relatively straightforward, buying a property to fix and flip requires a little more guesswork. The factors that go into the profitability equation for a fix and flip are:
Purchase Price (including transaction costs)
The purchase price should consist of the headline purchase price for the investment property, of course, but also closing costs for the purchase, selling costs (such as realtor commissions), loan origination costs, and the cost of interest on the loan for the time period that you will be holding the property.
After-Repair Value (ARV)
The after-repair value, or ARV, is the estimated amount that a property will sell for after it has been fixed up and is ready for sale.
Use your creativity and imagination to determine what would make a potential investment property an amazing property to a new purchase. Think about significant improvements such as opening up the kitchen, converting a dining room into a bedroom, or adding square footage to the property, including through a possible ADU (accessory dwelling unit). Be prepared with inspiration photographs of your ideas that you can show your realtor and your general contractor. Your realtor can tell you what the house could be worth with the improvements that you have in mind, based on recently closed comps in your market.
Next, approach your team of between one to three trusted general contractors to help you estimate rehab costs for the property. Show them the recent comps from your realtor and the inspiration photographs for the improvements you have in mind, and do a detailed walk-through of the property with each of them, describing everything you want to do in each room, on each of the six surfaces of the room. Once you have a detailed bid from each general contractor, compare the bids, ask questions, and make sure they are all aligned regarding the scope of work. Do not necessarily choose the lowest bid – that might be a crew of one person and could take six months to complete, whereas another bid might entail a four-person crew who can complete the work in one month. Understand whether the bids include all, some or none of the materials to be used in the renovation – for example, the contractors may expect you to purchase fixtures and materials directly, and they will handle the labor and installation. Once you have a bid that you plan to use (including materials), make note of that number and add some overage (for example, 10%).
The objective of flipping an investment property is to sell it for more money than was invested into the purchase, financing and renovation. Unanticipated expenses, market changes, or a longer period before the sale of the property can cut into expected margins.
The expected profit on a fix and flip is calculated as:
After-Repair Value – Purchase Price – Rehab Costs = Profit
If you do not have sufficient cash on hand to cover the purchase price and rehab costs, then you will need to consider available lending options, as described below. The ARV and rehab costs that you determined above will help you estimate what your purchase loan will look like.
For real estate investors, loan options can be limited. Traditional mortgages are not generally an option for investment properties. Accordingly, investors need to consider alternate forms of lending. In many cases, this means hard money loans.
What Is a Fix and Flip Hard Money Loan?
Hard Money Fix & Flip Loans are a great option for financing fix and flip properties. Fix & Flip Loans are more lenient than traditional loans, in that they generally require no income, asset or employment verification; credit score and history is of very little relevance; and they can be funded very quickly. These loans are typically costlier than a conventional loan, so they should be viewed as short-term financing (up to 12 months).
How Do Fix and Flip Hard Money Loans Work?
Hard money loans are available based on ARV, in contrast to traditional mortgages that are based on the amount needed to bridge the gap between a down payment and the purchase price of a property. You will provide your lender with the recently closed comps to support your ARV (making sure that the comps are near your property and with a similar square footage).
Depending on your prior experience level with fix and flip investments, lenders will generally lend around 70% to 75% of ARV, subject to a minimum cash down payment toward the purchase price (usually around 10% to 15%, depending on your credit score). Your cash down payment is the lender’s way to ensure that you have skin in the property investment.
Hard money loans generally have a short term such as 12 months, with no prepayment penalty (so you can pay off the loan sooner once you sell the flipped property), and offer interest-only payments, allowing you to keep more cash on hand for the repairs on the property.
As an example, if a property has a purchase price of $650,000, rehab costs of $100,000, and an ARV of $1,000,000, a lender might offer the following:
$1,000,000 x 75% = $750,000 – this is the maximum amount that the lender would lend based on ARV
$750,000 – $100,000 (rehab costs) = $650,000 maximum toward the purchase price
However, because of the 10% minimum down payment, you would be required to put down $65,000 toward the purchase price, and the lender would lend the remaining $585,000 toward the purchase price.
The lender would also lend the $100,000 for the rehab costs, which can be available as a construction draw where interest accrues only as you take the draw.
Thus, the total amount available from the lender is $585,000 + $100,000 = $685,000.
The Benefits of a Hard Money Loan
Fix and Flip Hard Money Loans can be an extremely valuable asset for those who need money to purchase a property to fix and flip.
First, hard money loans are among the easiest options for those who need a loan but do not qualify for a standard mortgage. Hard money loans do not have low ceilings like unsecured personal loans and have terms appropriate for a fast fix and flip process. They are also specifically secured by real property; in fact, they are designed for this purpose.
Second, barriers to access are far lower. As the value of the property is the most important element in lending, there are far fewer hoops to jump through. Approval can be faster and less hassle than other kinds of loans – a benefit in a market that moves quickly, like real estate. Less red tape is a favorite advantage among investors.
Third, investors hold the deed to a purchased property. Unlike a traditional mortgage, in which the lender maintains possession of the title or deed until the loan is repaid in full, you as an investor will keep the deed from the time of purchase. The lender will still put a lien on the property and foreclosure is still a possibility if the loan is not repaid according to terms, but the deed will be yours.
Fourth, the condition of a property is not a factor. Traditional mortgage lenders usually will not agree to lend money toward a property that is in poor condition, but hard money lenders are not restricted by the same limitations. Because the after-repair value is used to evaluate the loan, a property in need of renovation is a rule, not an exception.
The Bottom Line on Hard Money Loans
For investors who want to invest in a great property to fix and flip but do not have sufficient cash on hand to cover the purchase and repair costs, hard money loans are among the best opportunities to finance a property. Available without the limitations of a traditional mortgage while still using property as collateral, these loans can help make buying a reality. Despite slightly higher interest rates and limitations on borrowing amount, the right loan can make it easy to buy a property, make necessary repairs, and turn a profit.
Westpark Loans is a nationwide, direct hard money lender, including Fix and Flips! See our Loan Programs and how Westpark Loans can help you fund your next loan with a loan program that works for you! View our Success Stories, Reviews, and learn more About Us. Or, call to speak to a professional Loan Officer at 844-574-5626 today!