Are you clueless about funding a flip? Many new flippers get tripped up in this process, and I was one of them. Unfortunately, it delayed me from getting started. I believed there was only one way to purchase and renovate a house: Having the cash. While that may be the ideal situation, there are plenty of other ways to fund a flip.
When you’re starting and building your profits, you must know all the options you may have access to. I always have and always will tell you from experience with over 150 flips I learned you should never have one of anything.
I’m going to outline the most common ways to fund a flip. You’ll be able to see the details and the steps to access each as well as the situations where each may be most useful. The great part about funding your flipping business is more opportunities become available with more favorable rates as you progress in your business.
Now, it’s time to start! If you’re caught up on the risk vs. profit idea, refer to this article to learn more ways to look at profit and better understand this before moving forward
Steps to Avoid
Before looking at the options you have, I want to touch on my recommendations for what to avoid when looking for funding.
- Waiting until you need the funds to consider your options.
- Assuming that an option won’t work for you before knowing the details.
- Committing to only one type of funding.
5 Types of Fix and Flip Loans to Fund Your Flip
Fix and flip loans are a unique type of loan that investors use to secure the property and also cover the renovations.
Hard Money Loan
Hard money loans are non-bank loans from private investors or individuals. Hard money lenders have lower qualification requirements and can provide funding for flipping houses in just one to two weeks.
Utilizing hard money lenders changed my business. That being said, I had completed several flips before I started to use hard money lenders. When I started, hard money lenders were not even an option since they didn’t exist.
Since hard money lenders work with less qualified borrowers, they charge higher interest rates, in the neighborhood of 10% to 20%. They also have fees that can increase the total cost of the purchase so you need to account for that when you are analyzing your project. Therefore, it’s better to consider other, more affordable options first—before applying for a hard money loan.
Think of hard money loans as a way to “tide you over” until you complete the renovations on your property and sell it. As a result, the average hard money loan has a one-year term, although longer options are available. Hard money loans also require a relatively small down payment (usually just 10 %) because the lender cares more about the potential of the property than the background of the borrower.
Moreover, hard money lenders are pretty “hands-on” once they approve your loan. They generally extend the loan in parts. First, they’ll give you the money for the home purchase and the first set of renovations. Once the contractor completes initial renovations, you’ll get the money for the next set of renovations, and so on.
A variety of private business loan lenders and online platforms specialize in hard money loans for fix and flips. Start your research online, and don’t be afraid to look outside your immediate location. There are companies who lend all over the country.
Home Equity Line of Credit
A Home Equity Line of Credit (HELOC) loan is an option for people who want to fix and flip and already own their own home. For this to work, there would also need to be at least 20% equity in the home that is owned.
Using the equity in your personal residence can give you access to funding for flipping. The money can be drawn as needed and interest paid on only the money that you use.HELOCs typically offer favorable interest rates. There is a lump sum amount, whereas, with a line of credit, you can borrow up to the limit as needed.
Equity is the difference between the market value of your home and the amount owed on the mortgage. To qualify for a home equity loan or line of credit, you should have at least 20% equity in your home (ideally more—depending on how much you want to borrow). You should also have good credit and enough monthly income to afford your mortgage payments and pay off the HEL or HELOC.
Most banks will let you borrow 75 to 85% of the value of your primary residence, minus your outstanding loan balance.
- You have 30% equity in a $300,000 house. That means you still owe $210,000 on your mortgage. A bank would extend you a maximum loan or credit line of around $45,000. If this isn’t enough money to complete your fix and flip project, you can combine this funding option with other financing methods.
Using a 401(k)
These fix and flip loans are best for house flippers who have retirement savings, either through an employer 401(k) or another 401 (k) plan, and do not need the funds for an upcoming retirement.
Financing your fix and flip by taking out a loan or withdrawing from your 401(k) account isn’t the best choice for someone approaching retirement. On the other hand, it can be a great option if you have a few years before you need the money.
Most employer 401(k) accounts let you take a loan of up to 50% of the account balance, or $50,000, whichever is the lower amount. Solo 401(k) plans for self-employed individuals also allow loans of up to $50,000. You do pay interest on the loan, but the money is yours, so you’re paying back the principal and interest to yourself.
Taking a loan from your 401(k) might be a worthwhile option, and one I used myself when I was working full-time and flipping 3-4 houses a year.
This fix and flip financing option is best for transactions where the seller doesn’t mind structuring the sale unconventionally. Seller financing, also called owner financing, is when the seller of the home acts as the lender.
Instead of taking a mortgage from the bank or a lending company, you ask the seller to finance the fix and flip deal. Most homeowners want the money from the sale of their house right away. But it doesn’t hurt to see if the current owner is interested in seller financing, especially if they’re eager to sell the home quickly.
Seller financing offers advantages to both the owner and the flipper.
- Consider Sarah Seller and Bob Buyer. Sarah is retiring and selling her fixer-upper for $100,000, and she agrees to extend a loan to Bob. They agree on a down payment of 5%, a 4% interest rate, and a maximum term of six months.
- Bob gives her the $5,000 down payment now, and a promissory note for the remaining balance. He pays interest monthly.
- Bob spends $25,000 renovating the house and sells it for $150,000. After selling the home, Bob pays Sarah the $95,000 balance and remaining interest. He also pays his contractors for the renovation.
- Accounting for interest and the cost of the renovations, Bob made nearly $24,000 in profit. And Sarah is happy, too, because she got a nice return on the proceeds of her sale.
Usually, the flipper makes interest-only payments until they sell the property, at which point they pay off the seller in one lump sum. The seller can set a “balloon date,” a specific date by which the borrower has to pay back the loan. By that day, the borrower either has to sell the property or get a new loan to pay off the seller.
As with partner financing, you should have the terms of an owner financing deal in writing. Since the seller here is a third party (not someone you know, as is typical with partner financing), it’s wise to have a lawyer draft up the loan papers. As we see interest rates increase this type of financing may be a great option considering many mortgages have a 3% or less interest rate.
Business line of credit
Once you’ve been flipping properties for a while, the possibility of bank financing sometimes opens up. This fix and flip financing option is best for experienced flippers with a history of successful deals and regular income.
As we mentioned, traditional bank loans don’t work well for fix and flip funding, however, business lines of credit can offer investors funding for house flipping. With a business, or commercial, line of credit, you get access to a specific amount of money, but only pay for what you use.
A business line of credit is ideal when you’re unsure of how much renovations might cost on a property or how long a renovation might take. Business lines of credit work like a HELOC, but the difference is the amount of money at your disposal. Commercial lines of credit can go up to as much as seven figures, based on your business’s income and your portfolio of fixes and flips.
You can apply for a commercial line of credit at your local bank. Bank of America, Chase, Wells Fargo, and smaller community banks all offer small business lines of credit. The interest rates on these are very low but remember—to qualify for a commercial line of credit, you’ll need to have an excellent credit score (above 700), a decent amount of money in the bank, and a stable history of revenues.
A private lender is someone who has a lot of capital to load you for your flip. Think of this arrangement like a hard money loan, but with better rates and terms. Before jumping in, think about this option from the lender’s perspective. Understanding the risk they are taking and the communication they will need is an important first step.
Private lenders can be people you know or people you seek out. Private lenders often go to networking events, or through real estate agents. As you look for potential private lenders, keep their information and make real relationships you can use down the line.
Here are a few tips to vet private lenders and find your perfect match:
- Ask for references of past flippers or real estate agents they have worked with.
- Verify they have the correct licensure to lend.
- Set out expectations and guidelines clearly.
- Agree on all terms and conditions and agree
Buying my first flip
Back in 2007, I had to piece together the funds for my first purchase. After being turned down by several banks, I used a traditional mortgage, a 401(k) loan, and a cash advance from a credit card. The mortgage covered the purchase and the 401(k) loan and cash advance were to fund the renovations.
It may not have been pretty, but that first project yielded a $27,000.00 profit. Take this as an example of how creativity is more profitable than waiting for the perfect funding plan!
Ready to take that next step when it comes to flipping?
Here are some resources I’ve put together to help you get the information you need to move forward on creating your flipping life.
Make sure you have the Fixer Upper Checklist so you know which areas are key to added value in a home.
If you’re interested in learning more about the House Flip Blueprint course go here.
There are several videos available on finding houses, renovations, and funding on YouTube. Check out your favorite flipping topics and new videos weekly.