Flipping a home means buying a house for a profit. It's a profitable real estate investment strategy, but home improvements to increase the property's value can be costly. Plus, traditional financing options aren't always available.
In this article, we'll discuss the major costs associated with flipping a home, loan options for flipping a home, and how to get approved for a loan. We'll then explore tips to help new investors finance their home flip projects.
How much does it cost to resell a house?
If you’re new to the real estate business and are considering flipping a home, the first thing you need to know is that it can be quite costly. You need to be in a stable financial position before you decide to invest in flipping a home. These costs fall into a few categories:
Down Payment: Whether you take out a traditional mortgage or other financing sources, a down payment will be one of your biggest costs. Depending on the type of loan, a down payment can be as low as 3% to 3.5%. However, if you take out other financing sources, your down payment can be significantly higher. Financing Costs: In today's market, you can secure a mortgage with an interest rate of 6% to 8%, depending on the type of loan. Meanwhile, interest rates on hard money loans, which are often used for home flipping, can easily reach 15% or more. Homeowners Insurance: While you may only own your home for a short time, you need homeowners insurance to protect your investment until you sell it. If your home is being used as collateral, your lender may require insurance. Property Taxes: Property taxes and real estate transfer taxes should also be factored into your calculations. Even if you only own the property for a short time, you are still responsible for paying the applicable taxes. Marketing: When it comes time to sell, you will either incur the cost of advertising the property yourself or pay a real estate agent a commission (usually around 6%). Either way, your profit margins may be reduced depending on whether you do the marketing yourself or hire an agent. Renovation costs: The last big expense to consider is the cost of renovations. Changes and repairs can have a big impact on your bottom line. For example, renovating your kitchen can be much cheaper than adding a new wing to your home.
There are lots of tips and tricks that experienced home flippers use to save money. The costs of buying, maintaining, renovating, and selling a home can be overwhelming, but how you pay for these expenses can make a big difference. Whether you're buying a home with a loan or flipping it for cash, you'll need upfront funding to get the project done.
By some estimates, the total cost of flipping a home is 10% of the home's purchase price. However, costs vary depending on what improvements you make and how you finance your investment. Some investors believe you should leave room in your budget to ensure you don't pay more than 70% of the property's value after repairs. Some home flippers carefully budget the costs of each home. That said, it's important to leave a buffer for unexpected expenses.
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The best type of loan for reselling a home
A home resale project will likely require financing.
The most common types of financing that borrowers turn to are:
Hard Money Loans
One of the most common loans used in home flipping is the hard money loan. Hard money loans are easier to obtain because the lender doesn't primarily look at your credit. Hard money loan lenders will pull your credit report, check your credit score and credit history, and then calculate your debt-to-income ratio (DTI), but they don't just look at your credit score. With a hard money loan, the amount of equity you have in your home is very important. Because your home is used as collateral, you may need a higher down payment.
Because hard money loans don't require you to go through a lengthy screening process, approval times are much quicker and you may be able to get a loan even if you have a blemished credit record. The downside is that origination fees and interest rates can be much higher than a traditional mortgage.
Traditional Mortgages
Depending on the level of resale you are hoping for, there are several types of traditional mortgages available to you. Let's take a look at some options.
Renovation Loans: Renovation loans have traditional mortgage rates and require an appraisal. These loans help with renovations to a completed home. Renovation costs are included in the loan because they are assessed based on the property's after-repair value (ARV). Cash-out Refinance: With a cash-out refinance, you invest the existing equity of another home into the home you plan to resell. This can be one of the least expensive financing options because it's based on an existing primary lien. Because the home is already completed, there's less risk for the lender.
Private Loans
Financing from a private lender can be a good option, but often requires an existing banking relationship. If you have a long history of dealings with a private lender, they may determine that you are not a big risk, especially if you have an existing financial relationship.
The advantage of using a private lender is that you may have more choice in loan terms.
Personal Loans
The advantage of a personal loan is that no collateral is required. Loans are based on your credit score, credit history, and DTI. Approval is relatively quick and you can receive your funds in as little as one day. The only drawback is that interest rates can be higher than a mortgage.
Home Equity Loans
Home equity loans are ideal for homeowners who want to use the equity in their home to invest in property flipping, but don't want to touch their primary mortgage because they're happy with the terms of the loan. A home equity loan is a second mortgage, which means you have a second monthly mortgage payment.
A potential drawback of a home equity loan is that interest rates tend to be higher than a primary residence mortgage because in the event of a default, the primary mortgage lender recoups the loan costs first. For this reason, it is important to do the calculations and determine whether a home equity loan is a cost-effective solution for you.
Home Equity Line of Credit (HELOC)
A HELOC is similar to a credit card, but your home is used as collateral. With a HELOC, you are given a revolving line of credit based on the equity in your existing home. The line of credit has two phases: a draw period and a repayment period.
The drawdown period usually lasts up to 10 years. During this period, you only pay interest on the amount you withdraw. You can also pay the funds back into the HELOC and withdraw them again for your next project.
Over the course of up to 20 years, the loan will be fully amortized, meaning you'll pay back both principal and interest. You can't withdraw funds from the line of credit during the repayment period.
Bridge Loan
A bridge loan is a short-term loan that serves as a bridge between when you need the funds and when you can get longer-term financing. It usually has a higher interest rate, but it allows you to get money more quickly while you wait for a traditional mortgage or funds from other sources. The proceeds of the mortgage are used to pay off the bridge loan.
The risk with a bridge loan comes if the long-term financing fails, in which case you'll have to pay a shorter-term loan with a higher interest rate.
Crowdfunding
Crowdfunding your property flipping business has several advantages: you don't have to fund everything yourself or qualify for a loan, and if enough investors join in, you can get your project funded fairly quickly.
However, crowdfunding is not for everyone. There are some drawbacks. First, you need to advertise your project. You need to sell your business plan, but you need to understand that only a few people will accept your proposal. In addition, you may get a smaller percentage of profits, as investors are entitled to a share of the profits based on your arrangement. Finally, if your project fails, you will have to deal with disgruntled investors.
How to Get a Loan for a Home Resale
Whether you're getting a loan from a traditional lender, a hard money lending company, or a loan to flip a home, there are some differences in the loan process, which we'll break down.
Have your blueprints ready: Since the purpose of the loan is to renovate a home, you will need blueprints and estimates from contractors and others you work with to calculate how much the renovations will cost. Calculate your ARV: Lenders are also very interested in the value after repairs, because you will be paying off the loan with the proceeds from the sale of the home after repairs or renovations. The loan is based on the new value of the home, which is determined on paper first. Know your market: Appraisers assign a value to a renovated home based on properties that have similar characteristics to the newly renovated property. To avoid surprises, you should analyze recent similar sales. Determine your loan-to-value ratio (LTV): LTV compares the amount of the loan to the overall value of the home. If you are borrowing to flip a home, LTV is used to determine the mortgage interest rate for financing the first purchase of a home. Other things being equal, the smaller the down payment, the higher the interest rate. Check your loan-to-cost ratio (LTC). LTC is similar to LTV, but is typically used for commercial loans. Some lenders prefer it, depending on the type of construction.
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Can an inexperienced home flipper qualify for a home flip loan?
Inexperienced flippers will find it difficult to get approved for a home flip loan. If you don't have much experience flipping homes, lenders may assume you're more likely to default on your loan payments.
For new home flippers, the priorities are to understand the market, draw up a project plan and business plan, and raise some capital. You'll likely have to make a larger down payment and pay higher interest rates. You may have to initially deal with hard money lenders rather than traditional lenders that offer consumer-friendly forms of financing. Flipping houses is a tough business. Before you buy a property, carefully consider your options.
Conclusion
House flipping is the business of fixing up and renovating homes for a profit. There are many costs involved in acquiring the property, renovating it, marketing it, insuring it, and paying taxes.
When it comes to financing your project, conventional mortgages offer the lowest interest rates but are more difficult and take longer to qualify for. Hard money lending may place less emphasis on your credit score but offers higher interest rates. Other financing options include personal loans, bridge loans, home equity loans, and HELOCs.
If you want to get into home flipping, it's important to have a plan and understand the market. It also helps to have some funds saved up to increase lenders' confidence in you as a borrower. With enthusiasm and preparation, it can be a profitable investment opportunity.
Find a mortgage and lock in your interest rate today!
Find a lender that fits your financial situation.