Posted by Hannah Lapin ● Aug 17, 2021 4:58:57 PM
Guide to Fix & Flip Loans for Beginners
Flip or Flop, Chicago Flippers, Nashville Flipped, Phoenix Flipped, Lone Star Flip, and so on. There are dozens of HGTV shows designated to the fix and flip investment strategy. It’s fun to watch the projects from start to finish and learn the renovation strategies and which home features will succeed in the market. The big elephant in the room that never gets discussed, however: financing.
Maybe it’s not as entertaining as the large profits and new backsplash, but financing is a crucial piece to any investment strategy. In this post, we’ll take a look at fix and flip loans including:
- What is a fix & flip loan?
- Advantages & disadvantages of fix & flip loans
- Fix & flip vs. construction, renovation, or home loans
- Alternatives to fix & flip loans
What are fix & flip loans?
Real estate investors use fix and flip loans, also known as bridge loans, rehab loans, or residential transition loans, to purchase a property, improve it, and sell it for a profit. There are two components to fix and flip loans: the purchase and the funds for the rehab.
A brief side-note before we carry on; fix & flip loans are a subset of a broader category of loans called bridge loans. As mentioned above, a fix & flip loan typically includes both a purchase and a renovation or construction component. Some bridge loans do not include the renovation or construction component. For example, some real estate investors speculate by working hard to find off-market deals that they can purchase at discounts to market values. Rather than renovating these off-market homes for resale or conversion to a rental property, these investors may choose to sell the home to another investor that will do the rehab. To fund the off-market purchase, the investor might use a bridge loan. Similar to a fix & flip loan, a bridge loan typically has a relatively short term (3-24 months).
There are other uses for bridge loans on commercial properties. For now, we’ll provide one example. An investor buys a 20 unit apartment building. The investor plans minimal physical improvements but believes that can raise rents and improve occupancy rates through improved advertising. The investor obtains a bridge loan to buy the property and then executes their strategies with the goal of refinancing the apartment building into permanent finance after establishing improved property performance.
Finally, there are use cases for consumer bridge loans. These are outside the scope of this article. To learn more, you can start here: investopedia.com/terms/b/bridgeloan.
The purchase is relatively straightforward. The lender typically will size their total loan amount to both the after-repair value, or Loan-to-Value (LTV), and the total cost of the project, or Loan-to-Cost (LTC). Rates and fees vary greatly by geography, and terms generally range from 9 to 24 months.
The process for the purchase is similar to other types of mortgage finance. You complete an application, provide documentation, and order an appraisal. You also are required to provide a business plan for the property including a detailed renovation project with a timeline and associated expenses by project phase. Once your loan is approved, you close on the purchase, usually with you funding the down payment and the lender funding the remainder of the purchase price.
The rehab process is where fix and flip loans get interesting. You now own the property and want to begin to improve it. You need funds to buy materials and pay contractors. Most fix and flip loans require you to front this initial investment in materials and labor. Once you’ve completed a phase of the work consistent with your renovation project, you request from the lender something called a “construction draw.” This means that after the investor has made renovations, they can submit a request for reimbursement.
Once the request is received, a fix and flip lender will send an inspector to the property to approve the work, which will often take up to 72 hours. The investor then has to wait for the lender to receive the inspection report and release the funds. If you want your project to keep moving along in the interim, you have to have enough cash to fund additional materials and construction services. This may not sound like much in theory, but managing construction draws while juggling contractors and supply deliveries can be complicated and nerve-racking.
Advantages of fix & flip loans
Fix and flip loans are tailored to the fix and flip investment strategy, which has benefits to investors including:
- Quick financing
- Flexible terms
- Interest-only payments (low monthly costs)
- Ability to protect your other assets by financing through an entity
- Underwritten based on the investment rather than personal income
Disadvantages of fix & flip loans
There are some nuances associated with fix and flip loans that investors need to know including:
- High interest rates
- Short terms
- The need for upfront cash for renovations
- Potential for being charged on available but undrawn construction funds
Fix & flip loans vs. construction loans vs. renovation loans
Construction loans generally refer to loans that cover the completion of a new home from the ground up. A renovation loan is the type of financing someone would need to complete a remodel. The main difference between a renovation loan and a fix and flip loan is that a renovation loan is only structured to finance renovations, not the purchase of a property.
Fix & flip loans vs. home loans
A home loan is typically a loan for a borrower purchasing their primary residence. Home loans have 30-year terms and far lower rates than fix and flip loans. Home loans typically do not include financing for property renovations.
Alternatives to fix & flip loans
There are other options besides a fix and flip loan for rehab projects.
Get a Renovation Loan or a Personal Loan
Borrowers with high credit can get an unsecured renovation loan to finance their construction projects. This only works well when they do not need financing to purchase the property.
Refinance Your Long-Term Rentals
Fix and flippers who also own rental properties can pull cash-out of their existing rentals to finance their next flip.
Through Visio Lending, investors can access 30-year cash-out financing on their rental properties, including vacation rental properties, and use the proceeds to fund their next fix and flip project. Visio’s underwriting is based on property-level cash flow and does not require personal DTI calculations or tax returns.