Probably one of the most common questions about house flipping is where to get the financing for each flip. “Nearly everybody I talk to says that ‘money’ is the number one issue that prevents them from getting started flipping houses,” says Mike LaCava, investor and contributor to Bigger Pockets.
Bad credit, high debt-to-income ratio, and other financial factors can limit your financing options. People often make mistakes like paying too much for a property or investing too much of their personal finances. This can significantly limit not only your financial backing but your end-of-project cash flow.
Intelligently financing your house flip is one of the most important factors in the process. Here are three of the most common options for securing financing:
1. Use Traditional Lending… The First Time
Traditional lending (a.k.a. a conventional mortgage) is very rarely the chosen form of financing for house flippers. “Personally, I don’t like traditional financing as the right way to fund flips,” says LaCava. “I’d much rather flip houses with other people’s money like private lenders.”
That being said, he concedes that first-time home flippers can benefit from using a traditional bank loan for their first flip or two. Other lenders and investors will likely want to see your track record of flipping houses before handing over the money, but traditional lenders only care about your financial stability. If you have good credit and a low debt-to-income ratio, traditional lending can be a great way to jump into the market and prove yourself as a successful home flipper.
2. Private Money Loans
One of the most common ways to finance a flip is through private money loans, often called hard money loans. These are issued by either a private investor or a company. Hard money loans are typically good for flippers because the qualifications are much lower in terms of credit scores and debt-to-income ratios.
Even though it’s easier for those with lower credit scores to get funding, hard money lenders prefer higher scores. “Borrowers with better credit scores and a longer history of successful fix and flip projects will be seen as safer and likely qualify for lower rates and fees as well as higher borrowing limits,” explains Evan Tarver in an investing article on FitSmallBusiness.com.
There are some downsides to hard money, namely the high interest rates, but if you flip a house quickly, you won’t owe much in interest. Lenders also like to see some experience in the field before they’ll lend the money. Usually, a couple of projects will do. You’ll also need the help of an experienced contractor, so don’t plan on doing a lot of the work yourself to save money.
When all is said and done, this is a pretty simple form of obtaining financing and offers a unique advantage over conventional loans: “Properties in poor condition don’t satisfy guidelines for traditional mortgage financing. Hard money lenders, on the other hand, expect to lend on houses in disrepair,” says Lucas Machado, president of House Heroes, in an Investopedia article.
“Hard money lenders decide whether to make the loan by evaluating the strength of the deal and the reliability of the home flipper,” Machado says. “Should the flipper default, the hard money lender can foreclose, take ownership of the house and sell it profitably on their own.”
3. Private Investors
Perhaps the best, but often the most challenging way to obtain funding for your flip is through private investors. A private investor is an individual or company who wants to make an investment with a decent return, but without having to do the work themselves. You’ll take their money, paying interest and sometimes offering a percentage of your profits in exchange for their loans.
“A private lender is simply an individual with substantial capital to loan you,” says Mat Trenchard of Senna House Buyers in the same Investopedia article. “You would be surprised how many individuals are out there looking to loan money they have saved. They will operate much like an HML [hard money lender], except typically you can get better rates and terms.”
Private investors are often more willing to negotiate terms and rates. You might get a 12 percent interest rate with a hard money lender, but only 8 percent with an investor. It can be an extremely advantageous agreement if you know how to find such an investor.
The best way to find private real estate investors is to network as much as possible. Get to know brokers in your area, join financial communities and forums, and inquire about major real estate investments in the area. The more people you know and the more experience you get in the business, the more likely you’ll be to get financing through a private lender.