Today, a common way real estate investors make money is through “fix and flips.” This is a type of residential real estate investment where investors buy a property with the intention of quickly reselling it for a higher price. Generally, the property is a fixer-upper that they repair and renovate for the purpose of resale. A similar strategy, known as a “buy and hold,” is where investors buy a property with the goal of renting it out, or “holding,” until the market becomes more favorable to make a profit on a sale. Although fix and flips have the potential to be super profitable, a lot of money goes into the process from start to finish, making it a costly project. This is where fix and flip loans come in to help mitigate some of those costs.
What are fix and flip loans?
Fix and flip loans, also known as short-term bridge loans, can help investors alleviate the burden of home improvement expenses, which might range from minor renovations to a complete reconstruction. These loans are generally 12- to 18-month loans and start at $50,000. Two key factors lenders look at before deciding whether and how much to lend are the purchase price of the property and the after repair value (ARV). The ARV is how much a property will be worth after repairs are finished. Lenders can lend up to 90% of the purchase price and up to 100% of the renovation costs, not to exceed 85% of the ARV, with rates starting at 7.35%.
Generally, there are two parts to a fix and flip loan: the purchase and the rehab, which get broken down into phases.
The purchase phase is generally straightforward. An application is submitted to the lender along with supporting documentation and an appraisal. Additionally, investors need to submit a Scope of Work (SOW), a business plan for the property detailing the renovation in phases and associated expenses. Once the loan is approved, the investor can close on the purchase and begin the rehab part of the fix and flip.
Once the borrower enters the rehab process, they will need to lay out the cost for the first phase, which may include permits and demolition. After each phase, the borrower can request a reimbursement, known as a “draw.” Once the lender sees proof of payment, an inspector is sent out to see that those renovations are completed, and the draw is released so that the borrower can move on to the next phase of work. Once the rehab phase is done, a borrower can either flip the property for profit or move into a longer 30-year loan with much lower rates.
Fix and flip loans come with many advantages that make them appealing to real estate investors. These loans provide quick financing with flexible terms and interest-only payments, which keeps the monthly payments low. As these loans are typically short term, there is no prepayment penalty. Since the properties are generally purchased through an entity, the investor can protect their personal assets, treating this as an investment as opposed to receiving the draw as personal income. This means that in worst-case scenarios, the property becomes collateral for the lender rather than the investor’s personal assets.
On the other hand, fix and flip loans have disadvantages and are not always the best option. Because this is a short-term loan, interest rates are high. If the renovations take longer than expected or something holds up the project or sale, the interest can build up quickly, adding to the financial responsibility of the borrower. Many times, a lender will look to work with an investor who is experienced and has completed at least two flips already. So, a first-time borrower may face higher interest rates on their loan. Also, before a borrower can make a draw of any sort, they need to show that they have enough cash in the bank for renovations.
With the current lack of liquidity in the credit markets and strict banking specifications, it is becoming difficult for real estate investors to get their projects funded, making these loans a good option for many. Whatever financing option investors choose, they should make sure they are able to balance their responsibilities and focus on their projects without too many obstacles.
Written by Phil Dushey, CEO and President of Global Financial
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