Flipping homes can be a great way to make quick money in real estate investing. This continuously growing real estate investment strategy may look glamorous on TV, but it is not as easy as it looks. To get started, you need some cash for financing a flip project as well as a good knowledge about the costs of a fix and flip. In this blog, you will find all the information you need about financing a flip, which options are most suitable for you, and what the pros and cons of each financing strategy are.
What are the costs of a fix and flip project?
A fix and flip project is simply when a real estate investor purchases an investment property with the goal of reselling it for a profit. Profit is usually generated from renovations and capital improvement and/or through price appreciation of the real estate property. To understand this real estate investment strategy better, it is important to highlight the main costs associated with it because it is not just a matter of buying a house and selling it for a profit. In fact, costs determine greatly the options available for financing a flip.
So, what are the costs involved?
- The purchase price of the real estate property.
- Renovation costs.
- Down payment on loans.
- Loan interest and fees.
- Appraisal costs.
- Taxes and holding costs.
Now let’s look at the options available to cover these costs.
1- Traditional Bank Financing
The first option that might cross your mind when financing a flip is through conventional bank loans. How does it work? The bank simply pays for the real estate property, and you pay the mortgage payments until the house is sold. However, financial institutions are reluctant to finance flipping investments because they are considered somewhat risky investments. As a result, you will have to provide a minimum down payment of around 20% of the purchase price of the investment property. In addition, real estate investors need a good credit score and a successful history in flipping houses in order to qualify for a house flip loan. Therefore, traditional bank financing is most suitable for experienced “flippers” who have a good credit score.
2- Hard Money Lenders
Hard money lenders are organized money lenders who are licensed to loan money. Real estate investors should consider hard money loans for financing a flip when they don’t have a great credit score, and/or they have been turned down for a traditional bank loan. But this comes at a price. Hard money loans have high interest rates, usually falling in the double-digit range, which makes them a very expensive option for financing a flip, but on the other hand, they are easy to find and to qualify for. Additionally, hard money lenders generally expect their money to be paid back within a very short period (typically one year), which adds more pressure on the real estate investor to sell his/her flipped house quickly to avoid high penalties.
3- Private Money Lenders
Private money lenders are friends, family, or other private investors who are willing to lend you money to finance your real estate investment. Financing a flip with private money is quite favorable because you won’t have to jump through credit approval hoops, and you would probably avoid high interest rates in comparison to hard money loans and traditional bank loans. However, if you are going with this route, make sure to write down a contract so that the person lending you the money knows that you intend to pay him/her. Just keep in mind that with a contract, your friend or family member could sue you to recover his/her money.
Private money loans are more attractive compared to hard money loans since they are more flexible and cheaper, but hard money is easier to find.
4- Real Estate Crowdfunding
Real estate crowdfunding is an alternative option for financing real estate investments. Crowdfunding has become a popular way for real estate investors to finance various investments including financing a flip. So, how does it work? Well, real estate crowdfunding is relatively simple. Several people invest small sums of money in a real estate project that they are interested in, pooling their money together to finance a project.
There are two types of real estate crowdfunding:
1- Equity Crowdfunding
Equity crowdfunding is when an investor becomes a shareholder of the flipped property, and his/her stake is proportionate to the amount he/she invests. In other words, an investor actually ends up buying a portion of the real estate property that is being flipped. Investors receive a share of the selling price after a flipped house is sold.
2- Debt Crowdfunding
Debt crowdfunding means that an investor acts as a lender to the property owner, who is the flipper in this case. The loan itself is secured by the property being flipped, and investors earn money through interest charged on the loan.
5- Your Own Assets
What about your own assets? Even if you don’t have extra cash lying around, there other options for you to consider when financing a flip.
1- Independent Retirement Account (IRA)
Financing a flip using your IRA account is not very recommended as there are negative consequences if you don’t pay back the loan within the agreed upon time. However, as a flipper, you plan to sell the house as soon as possible and pay back the loan anyway.
2- Credit Card
Financing a flip using a credit card can be very expensive, and you should only use this option if you are certain to pay the credit card off quickly to avoid high interest rates.
Whether you opt for hard money lenders, private money lenders, traditional loans, real estate crowdfunding, your own assets, or a combination of them, you have plenty of options for financing a flip. The key is to find the option most suitable for your unique needs.
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