Find Your Green: Explore Different Ways You Can Fund Flips
When it comes to financing your next flip, you’ve got plenty of options. Explore which route might be best for your business.
Understanding how to fund flips can make or break your business.
You can have all the fixing and flipping know-how, but without funding to buy and renovate the property, your real estate investment business won’t get off the ground. The good news for flippers is that there are many ways to raise funding.
Each funding opportunity has unique pros and cons, and the one you choose will depend on your own financial situation, the state of the market in which you’re investing, and the way you want to run your business. Take a look at some of the most popular ways investors fund flips.
Hard money loan
Hard money loans are a popular way to fund flips. This short-term loan uses property (the “hard” asset in its name) as collateral. Hard money loans don’t come from mortgage companies, like you’d encounter in a traditional real estate deal.
Instead they come from private investors or a private investment fund. Hard money loans usually have terms from a few months to a few years during which the borrower generally pays only interest with a balloon payment at the end. This abbreviated timeline tends to work well for flipping houses.
Pros of a hard money loan:
- Speed. Hard money loans can be secured in as little as a week.
- Access to more funds. With a hard money loan, you can borrow the after repair value amount (or the amount you estimate the flip to sell for), allowing you to finance the renovation cost.
- Volume. A hard money lender won’t necessarily stop you at one deal. If you have a good deal track record, a hard money lender may be open to multiple loans.
- Flexibility. Hard money loans don’t fall under more standard banking rules and regulations. You may need little or no money down and your credit score may not matter as much.
Cons of a hard money loan:
- Higher interest rates. There’s a greater risk to the lender in a hard money loan and so interest rates tend to be much higher than a traditional mortgage.
- Higher origination charges and fees. Origination fees may be between 1 and 3%.
- Potential penalty for paying off early. Review the terms and make sure they work for you before signing.
Partnering with another person or group of real estate investors is a great way to fund flips. You can arrange your partnership any way that works for everyone in the group. You’ll want to have a lawyer draw up official paperwork, of course.
In a partnership where one person or entity is supplying the funds and the other one is managing (or doing) the work around fixing up the flip, or even have experience as a real estate agent. You’ll both benefit from the other one’s skill and assets. Someone with money to invest in a flip may not have the experience you do in real estate or rehabbing. By joining forces, you’ll both be able to profit from real estate investment.
Pros of a private partnership:
- Flexibility. You can structure the terms any way you’d like, and your partner may be more understanding if difficulties arise.
- Speed. A private financial partner can get the money to you ASAP.
- Open-ended. The only limit on the amount of money you borrow or how fast you need to repay it is agreed upon by you and your partner, allowing you broad latitude to strike a financing deal that works best for both of you.
Cons of a private partnership:
- Loan amount dependent on partner’s assets. If your partner is the bank, you can only borrow as much as the partner has access to.
- Your profit split. While how you structure the deal is up to you and your partner, it’s possible your partner will want a big cut of the profits in exchange for lending you the money.
- Differences of opinion. Private partners may want to be more hands on than a hard money lender. They may have opinions about the flip that you might not agree with but have to entertain due to the partnership.
Be sure to consult with a CPA and your own lawyer when considering this route.
Instead of relying on a lending group or a friend with money for funding, some real estate investors turn to crowdfunding to fund flips. This won’t be you posting your flip on a typical fundraising site like Kickstarter. Instead, you’ll be turning to crowdfunding investment platforms, which are set up for real estate crowdfunding. Financing may be debt or equity, depending on the platform and/or your preference.
Pros of crowdfunding:
- Connections to interested investors. Real estate crowdfunding platforms bring your project to a broad group of investors you’d otherwise not encounter.
- Seamless system of lending. A crowdfunding platform tailored to flippers may charge a bit more but it will have all of its systems tuned to lending for fix-and-flips.
Cons of crowdfunding:
- Higher interest rates than a conventional loan. Expect somewhere between 8 and 12 %.
- Longer wait times. Crowdfunding loans may take longer than a hard money loan to close. The timing depends on the platform. Some front the money and then get investors. Others wait for investors to sign on.
- Less flexibility. Since crowdfunding represents a larger pool of investors, there may be a more cookie-cutter approach to the funding.
Home equity line of credit
A home equity line of credit (HELOC) uses the equity in a home you own as a kind of credit card. Equity is the difference between how much the home is worth and how much you owe. Often you can borrow up to 85% of your equity. You can get a HELOC on any property you own, although it may be more difficult to get one on an investment property than a primary residence. A HELOC allows you to tap into your home’s equity for a set period of time and use the money as you wish.
Pros of HELOC:
- Flexibility with amount. You’ll be able to access your full equity but only pay interest on what you borrow.
- Reasonable interest rates. Interest rates are likely much lower than if you use a credit card or take out a personal loan.
Cons of HELOC:
- Difficult to obtain. Not all lenders want to offer HELOC, especially if you’d like to take one out on another investment property, instead of your primary residence.
- Higher bar to approval. Lenders will likely look at things like credit score and liquid assets when deciding to approve a HELOC.
- Variable interest rates. Interest rates are often variable and higher than you’d prefer, especially if the loan is on an investment property.
- Risk losing an existing home. If you can’t pay the HELOC back, you may lose the home that’s acting as collateral.
Home equity loan
A home equity loan (or second mortgage) allows you to borrow on the equity in your home, like a HELOC. However, a home equity loan is for a fixed amount and a fixed interest rate, resulting in predictable payments. Like a HELOC, interest rates on a home equity loan are likely better than what you’d get on an unsecured loan, like a credit card. Generally you can borrow about 80 to 85% of your equity with a home equity loan.
Pros of a home equity loan:
- Lower interest rates. Interest rates are likely lower than if you use a credit card or take out a personal loan.
- Fixed payment schedule and interest rate. Unlike with a HELOC, you’ll know exactly how much you owe every month with a home equity loan.
Cons of a home equity loan:
- Risk losing an existing home. If you can’t pay your home equity loan back, you may lose the home that’s acting as collateral.
- Limited funding. Unless you own an expensive home and have a lot of equity, this type of loan may not offer enough money to finance a flip purchase and renovation.
- Requires cash flow. Bank will require you to have the funds to cover both your original home loan and your second mortgage.
Consider all options and choose what’s best for you
As a flipper, you have lending options for both purchasing the home you want to flip and for renovating it. The funding option you choose will depend on your individual circumstances. You’ll need to weigh the need for speed in obtaining the loan versus interest rates, and added fees.
Also consider what kind of partner you want, whether a hands-off private lender, an involved partnership, or a connection on a crowdfunding site. Working with a person or company that has experience in loans for flippers can help make sure things go smoothly and work in your favor. Make sure you think strategically to maximize your ARV and keep the 70% rule in mind before making any investment.