How to finance your house flip
There are several routes you can take when financing the purchase of a house you are flipping – cash, private money, hard money, etc.
At LendingHome, we like to think that there are six F’s of real estate investing: Find, Finance, Fix, Fill, Flip, and, of course, Fun. We covered how to “Find” houses to flip in a recent blog article (check it out if you haven’t yet), so it’s time for the next one — “Financing”!
Say you’ve found the house you want to flip, and now it’s time to make an offer on the property. In this blog post, we’ll go over your options and how to decide which option is the best fit for your deal and your business. We’ll do a pro and con analysis of the following:
- Private Money: Private Lender
- Private Money: Friends and Family
- Hard Money Lender
Let’s jump in!
Once upon a time, an investor proclaimed “cash is king.” And, depending on the circumstances of your deal and your plans to flip other houses in the immediate or near future, cash might be the best option. If you have the cash reserves to buy a property in full, here are some things to consider:
Speed. As with commercial or retail transactions, cash purchases happen very quickly. The lack of intermediaries, banks, escrow companies, etc. ensure the quickest possible turnaround time from the property belonging to the owner to the property belonging to you.
Inexpensive. Taking out a loan incurs borrowing costs. There are often application fees and origination fees upfront, and then monthly interest payments for the duration of the loan. Buying in cash means avoiding these costs, which helps your margins.
Ease. Borrowing money can be a time-intensive and often painstaking process. Loan applications will often require you to send in lots of documentation, such as bank statements, tax returns, and other personal info that may be difficult to gather in a timely manner. Also, have you ever used a fax machine? It’s no fun. Many lenders, especially mortgage lenders, are still highly dependent on outdated systems.
Capacity. Houses are not cheap — the median cost of an American house is around $200,000. Not many people have cash reserves that large.
Scale. Say you did have $200,000 liquid in cash reserves. If you buy one property in full, you can’t do much else until you sell that property. But if you put down 30% and finance the rest, you could flip three homes of the same price concurrently. Deals do not come along in a linear fashion, and there is opportunity cost associated with having all your cash tied up at once. Flippers trying to scale their business and do multiple deals at the same time will often move away from cash and towards financing, no matter how large their cash reserves.
“I was able to multiply my efforts and do more deals. I have personal financial goals and working with a lender [LendingHome] was a way to reach those goals. If you just use cash, you only have so much and may be able to do only two properties at a time,” says Cathy Gould, a LendingHome customer and property investor in Stockton, Calif.
Risk. Being the sole owner of a property is great when things go well, not so much when things go poorly. When you buy a property in full, you can only take as much cash out as the property is worth. In a severe economic downturn, or if something unforeseen happens during your flip, value can disappear quite quickly.
Ever asked your friend for 20 bucks? Then you’ve experienced what it’s like to borrow from a private money lender. If you opt not to buy in cash, and you have private financiers in your network with the necessary funds, this could be the route for you. We’ll split private money lenders into two categories: private lenders and friends and family.
When we say “private lenders” we are referring to third parties whom you may not necessarily have a close relationship with. These are financiers in your network that are not official corporations and therefore are not regulated in the same way that banks or hard money lenders are. These lenders may offer you funding on a deal-by-deal basis, or offer you access to a line of credit.
Speed. Depending on who the lender is and size of the loan, money can be wired to you within hours. With a private lender, sometimes you find the right deal, make some calls, and boom — the money is in your account. This turnaround can be the difference between winning a bid and losing it.
Ease. Whereas banks and hard money lenders are heavily regulated and process-oriented (for good reason), many private lenders do not have a rigorous check/balance system for wiring funds. Again, it all depends on the lender, but chances are your private lender will require much less paperwork and documentation than your average hard money or institutional lender.
Cost. Once you’ve established a relationship with a private money lender, you’ll probably be able to negotiate favorable pricing for subsequent deals. Sometimes it’s even possible to negotiate down to 7-8% rates and origination points of 0-2%.
Flexibility & leverage. Private lenders will likely take on more different types of deals than institutional lenders, whose credit policies are more rigid and more regulated. Say you typically buy single family homes in the suburbs, but stumble across a multi-unit residence such as a duplex or apartment building. If you’ve established a rapport with your lender and can make your case, they are more likely to take on the project than a bank or hard money lender. Same applies with leverage — if you find yourself in a situation where you need to finance 90-100% of the property, private lenders may be able to make an exception.
Local. Given the nature of most private lender/borrower relationships, chances are, your private lender is in your market or at least close to it. Being in the same time zone, sharing business hours, and being able to meet in person will all save time and money.
Capacity. Remember that friend that loaned you 20 bucks? She may not have 20 more to loan you next week, especially if you haven’t paid her back. The same applies to private lenders. They often have much more finite funding capacity ($200,000 – $1 million) than banks or hard money lenders. So if you want to do multiple deals at once, or bigger deals, that may not be possible.
Cost. We know we mentioned this in the pro list above, but private lenders can be all over the place. Many private lenders can be more expensive than institutional lenders, especially early on in your relationship. The rates can be as high as 10-14% and 2 to 5 points in origination fees. It all depends.
Consistency. (Last time we bring up your friend and the $20, we promise.) Imagine you’re using those those 20 dollars to get on the train to go to work. That’s fine to do once or twice, but probably not a habit you’d want to start. You don’t want your job to depend on her lending you money! Private lenders are not ideal partners to scale a business with, because most will eventually want to take a breather from lending, lend in other areas, or just quit lending altogether. If you’re building a real estate investment business, you’ll want a lender you can rely on every time for every deal.
Support. Banks and institutional lenders have business hours, and you can almost always expect to catch someone on the phone during those listed hours when you need help with something. A private lender may just be one person with money and a cell phone, and if that person goes on vacation, or just doesn’t want to pick up, there’s not a whole lot you can do. As mentioned above, these are not the type of issues you really want to run into when running a serious business.
Friends & Family
Many flippers who don’t have the cash reserves to buy a property in full start by borrowing from friends and family who have the necessary capital. A loan from friends or family can feel a lot like cash, given the casual nature of the agreement, speed at which money will exchange hands, and lack of regulatory/legal ramifications. It can have its downsides, though. Let’s explore pros and cons:
Speed, ease, flexibility, local. All of the above benefits from private lending apply to borrowing from friends and family. If anything, you can assume that taking out a loan from a close friend or family member will be faster, easier, and feature more flexible terms than from a third party.
Capacity, consistency, support. All of these cons from private lenders also apply.
Can get personal. Obviously, there are many risks associated with financing and flipping homes. Your rehabilitation may not go as planned, you could have made bad assumptions about the market or the property, or, for whatever reason, the home may just not sell. When lending from a third party, especially a lending corporation or institution, there are no hard feelings. Foreclosure or short sell processes will be put into place and investors will recoup as much as they can. However, when personal relationships are intertwined with business, things may not be as simple. Consider how the various outcomes of your project will affect these relationships. If failure would be more than just financially problematic, maybe you should go a different route. You don’t want to be uninvited from the next family reunion!
Hard Money lenders
Finally, let’s talk about hard money lenders. Hard money loans, also known as bridge loans, are short-term mortgages for real estate investors and are alternatives to cash and private lines of credit. Hard money loans are designed for new and experienced investors alike, with rates typically varying based on the experience and credit worthiness of the borrower. LendingHome, for example, offers hard money loans ranging from 7.5% to 12.75%, as of the date of this posting.
Consistency. When scaling your flipping business, predictability is key. You’ll want to know exactly what to expect at every step of the process as far as approval process, the documentation required, and closing timelines. With private lenders, the inconsistency of the lending process can be difficult to scale your business around. Hard money lenders such as LendingHome have gotten this down to a science, with predictable pricing, minimal documentation, and fast close times. They provide the framework for you to grow your business.
Access to capital. Hard money lenders will have much more capital on hand to lend, and you will likely never run into the type of capital constraints you would with a private lender. LendingHome has hundreds of millions of dollars in capital to fund your deals, and Preferred Members have access to a $5 million credit facility for use on as many properties as they wish to finance.
Value-add. Hard money lenders will likely be able to share valuable advice and information with you, given their experience in the industry. At LendingHome, we’ve seen thousands and thousands of deals, so we know what goes into making a flip successful and what may cause issues in the process. We have a Feasibility team which will review your scope of work and let you know if you’re taking on too much in your rehabilitation project. Our Valuation team will review your appraisal and the neighborhood to determine the price to list your property at after it’s been rehabilitated. The return on investment (ROI) calculator in our loan application will keep you from getting into deals which won’t make you money. At LendingHome, we serve as a partner to our borrowers, offering much more than just capital.
Support. Hard money lenders will often have personnel assigned to your loan to help you should anything come up. At LendingHome, from when you first submit your loan to when you pay it off, you’ll have a dedicated team on-call and ready to help.
Leverage. Most hard money lenders will have caps on the percent of the property’s value you can finance. LendingHome will allow experienced borrowers to finance up to 90% of the property’s purchase price, and first-time borrowers may finance up to 85% of the property’s purchase. That said, LendingHome offers its lowest rates for lower leverage brackets (e.g.: as of the date of this post, if an inexperienced borrower finances 75% LTC, his/her rate will be 10%, whereas financing 85% LTC will be a rate of 12%). If you are looking to finance a property in full or at a very low rate with high leverage, hard money lenders likely won’t be the best option for you.
Upfront cost. To cover the costs of originating a loan and to ensure that applicants are serious about moving forward, hard money lenders will charge upfront costs. LendingHome charges an application fee (except for our Preferred Members), an origination fee (to be paid upon close), and a service fee (also to be paid upon close). These three fees allow us to cover our business expenses and return value to our investors. However, they do obviously incur a cost to the borrower.
Flexibility. Private lenders will often be able to come to certain agreements and have a tolerance for negotiation on a deal per deal basis. Hard money lenders, given their scale and the responsibility they have to lend legally and responsibly, will have tighter credit boxes with less wiggle room. Certain exceptions may be made depending on the lender and borrower, but typically, a lender will have a certain list of property types, geographic coverage, and deal sizes that they are comfortable working with.
We hope you found the information useful! We’ll be back soon with the next of our F’s: Flip.
Click here to learn more about LendingHome Bridge Loans.