Feb
22
Financing House Flipping
February 22, 2007 |
Probably the largest obstacle to successfully flipping a house isn’t so much locating and renovating the property, but more simply coming up with the necessary money to make it all happen.
We’d all love to have the option of simply paying cash for an investment property but the vast majority of us don’t have that much free cash lying around, especially when first starting out. That’s a great goal to shoot for, as paying cash lets you boost your profits and turnaround time by avoiding mortgage application and processing fees, but it’s just not a viable option for most investors.
The best bet for most flippers getting started as far as financing goes is to go the mortgage route, as far as borrowing the money to buy those house. This eats into your bottom line as far as profits (especially if you have to make multiple mortgage payments) but that’s a necessary evil at the beginning stages, and hard to avoid.
One nice thing about flipping is that you’re typically holding the property for a short period of time (usually less than 6 months), so you can consider a wide range of mortgages, from traditional 30 year mortgages to interest only mortgages, ARMs, even 40 or 40 year mortgages.
You’re also typically not as concerned about the actual interest rate, either, as your goal is to make very few actual payments (if any). That’s not to say you shouldn’t shop around for the best interest rate, just that you shouldn’t be scared by a high rate if it has other obvious pluses, such as requiring 0% down payment. If you later decide to hang onto the house as a rental or until the market improves, you almost always have the option of refinancing.
Like any loan, you’ll have to qualify for financing. If you’ve got little income and terrible credit, don’t expect lenders to fall over themselves to give you money to try to flip a house. I haven’t encountered this personally, but apparently some lenders require higher down payments if you’re looking to buy an investment property, as opposed to a loan for your primary residence.
Avoid any shenanigans as far as trying to wrangle cash back from sellers under the table, after inflating the purchase price. It’s tempting for flippers to try such things, as in a perfect world your loan would also include money for the projected repair costs, so that your out of pocket expenses were close to $0, but sadly, that ain’t the way it works.
While it’s legal and acceptable to increase the purchase price to cover some or all of your closing costs, most lenders don’t allow you to inflate the price in order to increase the loan amount to also include repair money.
If you can’t pay cash and have terrible credit and otherwise can’t get a standard loan to finance a flip, pretty much your last resort is a hard money lender. These are essentially investors and smaller companies that cater to the desperate (often people trying to avoid foreclosure at all cost) who don’t mind paying very high interest rates.
For flippers, though, a hard money loan isn’t that terrible an option, for reasons covered above. If you’re only going to hold the property for a few months, the fact that the interest rate is 15% doesn’t really matter to you. Hard money loans typically require much less paperwork and can be done quickly, as they often don’t involve verification of income, great credit, etc.
Comments
17 Comments so far
I found your blog a few days ago, and I really like it. In particular, I like your critical outlook and logical analysis. Your thoughtful discussion of flipping really contrasts a lot of these other yahoos blogging about flipping.
Just out of curiousity, what town is 1002 S Main located in?
If you’re taking requests for future topics, I have some. I’d like to see a detailed rundown of all of your expected expenses on the flip (mortgage, closing costs, repairs, etc) and a summary of how much you think the value will increase–a cash flow analysis.
I’d also like to know more about why you think this unit is a good flip. What about it makes it undervalued? In previous posts, you’ve mentioned increasing the value as much as $30k or more, by doing only $5k worth of repairs. What factors are you counting on to cause this rapid appreciation?
In general, I’ve never seen a detailed summary of a real flip by real people who weren’t making a TV show. And none of the “gurus” seem interested in sharing information about their own successful flips. I’d like to see the profile of a real flip, and a real flipper.
Anyway, good luck with your blog, and I hope you keep it up in the coming months so I can see how this turns out. And good luck with the flip!
Aaron,
Thanks for the comment, and I definitely plan to address a lot of it in a post very soon.
I’m probably being paranoid, but my plan is to be coy about the actual town the properties are in. I just don’t like broadcasting the complete address of the properties to the world, although it’s hard to imagine any real downside. We live in central Texas, within commuting range of Austin and San Antonio, which should give a good enough idea of the market conditions, etc.
My next post is going to be a detailed look at the stuff you mention as far as dollars and cents, now that I’ve got a good idea of closing costs, insurance costs, quotes for some repairs, etc.
Most of the potential profit is more a function of getting the property at a sharp discount, as opposed to repair work I can do or appreciation of property in the area in general. The owner inherited the house from her mother and put it on the market at $84,500, it didn’t sell, dropped it to $78,500, then decided to rent it out.
Got unlucky with tenants from hell and finally said screw it after 6 months, as she needed the money from the sale of the house, so she was going to re-list it at $65,000 just to be done with it. The selling agent worked in the same office as our agent and knew that I was looking for flips and let him know about it before it was ever re-listed, which is how I ended up getting it at $60,000.
With unexpected repairs like replacing the furnace, repair costs are likely more like $7,500, and selling it for $85,000-$90,000 is probably the best I can expect. So I’m probably looking at a profit of $10-$15K when it’s all said and done and everyone gets their fee, taxes, etc.
But yeah, I definitely plan to detail the good and bad, for the reasons you mention. It’s fun to watch the assorted TV shows but they’re pretty far from realistic, usually set in CA during the housing boom, so I’m curious myself to see how all this works out in a much more realistic, real-world scenario.
You got me!! I’m guilty of increasing my most recent loan amount to cover the closing costs… but the discount on the house was so sharp (eventual sale - purchase - repairs - fees = $20K) that waiting around for my on-hand cash situation to improve would’ve definitely costed me the opportunity.
Also, as you mentioned, I found out the hard way that there is often a limit as to how much a seller can assist you. For my lender, that limit was 3% (for some others it’s 6%).
Along those same lines, regarding the terms of the loan that you get, you’re absolutely right in terms of the interest rate not mattering a whole lot. For one of the properties I have under contract now, I was able to take a higher interest rate (6.5% instead of 6%) and receive *negative* points on the loan. That concept was new to me, and what it basically says is that the lender will give *me* money back at closing, instead of vice versa. Again, a higher interest rate, but I don’t plan to pay more than 1 months mortgage.
Last but not least, it sounds like you are being realistic about your profit margin. That’s good to see. So many people don’t factor in fees, taxes, unexpected repairs, etc. But it’s best to be surprised on the positive side than the alternative.
PS… I think your coyness about your location is wise. And I continue to enjoy your posts. Good luck to both of us.
Great info. I just found this website last night and have been reading all of your posts. They are very informative.
I graduated high school last May and have been saving every dime and nickel I get to flip a house with. I currently have about $4,000 so I should be flipping one by the end of this year hopefully. My main goal as of right now (other than saving the money) is to do as much research as possible so that i may come out profitable. Thanks for the website, because it helps with everything I need to know.
By the way, I was wondering if you could help me with something? I live in a very small town in Central Texas with a population of about 1,500 people. I have been keeping an eye on the market for months now and on average: a “somewhat” rundown home, 2 bed, 1 bath, 800sq ft has an asking price of around $35-45K. A new home, 3 bed, 2 bath, 1,800sq ft would be listed for around $200K.
My concern about that is…is the margin between a fixer upper and a new home too small in my town to make a profit? if I flipped a $45K, 900sq ft. house and tried selling it for $60K do you think people would be still be interested? Or am I thinking wrong all together by factoring in the cost of new homes?
If you agree the margin is pretty small (i have no idea the difference of new homes and old home in larger towns, so i rely strictly on comments to decide), i might resort to doing a few foreclosed homes to get on my feet. then move on to a slightly larger town later on. One perk of a small town is, i know just about everyone. So going over to the bank and telling everyone there to alert me of foreclosures before they go onto the market wouldn’t be too hard of a task. And i think i might be able to get a good deal on a mortgage loan also.
So…sorry for the extremely long comment. but any help from the creator of these posts, or anyone with knowledge on the subject, would be greatly appreciated.
Justin,
I wouldn’t worry so much about the margin between fixer-uppers and new homes, as they seem to be two distinct markets, as far as what you’re subscribing. Someone looking for a 2-1, 800 sq. ft. house is probably buying their first home, and happy as hell to finally get out of an apartment, while someone eyeing a 3-2, 1800 sq. ft. house likely has a family, has probably already owned homes, etc.
I just try to look at each property individually, and the potential it has. Ignoring the extremes (a 400 sq. ft. 1-1 or a 8-3 4,000 sq. ft, mansion) there’s usually a market for anything, so if you think you have a good handle on the market in general and a property seems undervalued, then I’d say go for it.
I worry a bit, though, as to the size of the town, as 1,500 people is getting kind of wee, and it might take awhile to turn it around as quickly as you’d like, especially if you’re tackling deals with a smaller potential profit. (By smaller potential profit I just mean that a good flip might net you $5K to $15K in profits, as opposed to ridiculous scenarios on Flip That House where people in California make in excess of $100K per flip.) Assuming you get a loan for the flip, each month you hold it takes a chunk out of your profits, so being able to turn it around fairly quickly is important.
One thing I’d suggest is starting the process now, even if you think it’ll be the end of the year before you’re ready to get serious. There’s no penalty for lining up a realtor and a lender early, so you’ve got nothing to lose. Be as detailed as possible, let them know how much you have saved, what you plan to save moving forward, and what sort of properties you’re looking for. Good deals can fall into your lap pretty quickly, and you don’t want to miss out because you’re scrambling around for a loan, etc.
Thanks for the fast response seth. When I saw the last comment was left on Feb. 23th, i was worried i’d never get a comment.
As for the population, i definitely see where you are coming from. But houses sell more than you’d expect here. New houses and subdivisions are popping up left and right and I believe at the next census, our population will be much higher, possible a couple of hundred higher.
Thanks for the advice on everything, it was very helpful. What you said about establishing a Realtor, loaner, etc…is very true and i didn’t think about that much. That and the experience I gain from my first house will make up for any small profit gained(i think so anyways).
And since I’ve began with the questions, I might as well ask this: I just found a perfect house today, but there are things I’m unsure of (Researching mortgage loans and things on the internet can only do so much). It is a foreclosed home only about 1/2 mile from where I currently live. It went up for sale in November of 2006 for $42,250. I looked at it again today and saw that it is down to an amazing $35,900 as of last week (I’d ask to pay $30K)! It is 1,220 sq feet and 2 bed-1 bath. I believe that the only reason it has not sold is, it’s not advertised well. it is on one website only…it’s not even in the thrifty nickel. Some never-heard-of local real estate company has it and there is only a small sign in the yard, one side is covered by a tree! It need central heating/air, but only cosmetics other than that. I am a handy-man, so i will do ALL of the work…so here is my question…
If I go get a loan for $30K (if I can talk em down that much), plus the closing cost, plus about $5K for renovations, does it seem like a good deal to you guys? or should i not even attempt to finance my renovation costs? i just figured since the price is so good…? I think i could sell it for AT LEAST $50K! and that’s being WAY on the safe side. it might even go for around $70K looking at it’s competitive houses…just let me know what you guys think. Thanks
Justin,
Financing your renovation costs is next to impossible, unless you want to try to work out a shady deal with the owners to jack the price up and give you cash back under the table, when it closes.
Some lenders will let you increase the loan/asking price by 3-6%, in order for you to borrow the money for closing costs, but that’s all the leeway they’ll give you. Unless you go with a hard money lender, you’re not going to be able to borrow the money for the renovations.
If you can move it quickly, you could make a decent profit, assuming all your numbers work out (buying it for around $30K, selling for around $50K). Don’t forget, though, that you’re paying commissions to the buying and selling agent when you unload the place, which eats into your bottom line.
well, i know the head guy at the bank, i guess he’s the owner…or something. And I’m going to ask if he could finance the renovations as well as a favor. If not, then I might still buy it (since it’s such a good deal) and continue to save while making payments. I’m pretty sure the price of the house is WAY lower than anything else I am going to find. The second cheapest one next to this one is $42K, it’s half the size and in WAY worse shape.
And as for the real estate agent commission… I’d have to pay them the commission!?!?! I thought that came out of the selling price? And I will be selling the house myself, with no agent. Just the thrifty nickel, maybe some fliers, and a “For Sale By Owner” sign in the front yard. All starting the day I purchase the house (rather than when I am done) That will save me money also.
Also, i did some more research today. I can DEFINITELY get around $75,000 for this house post flip. But that’s factoring in Central heating/air, all new floors, all new stainless steel appliances, and LOTS of curb appeal (also turns out is 3 bedroom, 2 bath, 1220sq ft!). I think I can come out with a profit of at least $20K. But like I said before, even if I only make $5K, i will be happy. So if anyone here thinks I should go get the loan for all renovations and EVERYTHING, even if it means going to a hard money lender…tell me I should do it. I have no one with ANY knowledge of these things to talk to. I need some support to know if I’m doing the right thing. I am really anxious to get my life started off making lots of money. I turn 19 in a few months and it;d be great to be a somewhat “experienced” flipper by then.
Justin,
Well, I was assuming you’d use an agent to sell the house, so yeah, you only pay a commission to the agents when selling.
As far as selling it yourself, that’s making your job a lot more difficult. I know it seems easy, in theory, and some investors managed to go the FSBO route and do just fine, but I think that’s biting off a lot, especially for your first shot at this. Based on your description of the property earlier, it sounds like they used exactly the same marketing techniques that you’re planning on using, with little success so far. FSBO is really, really difficult, as there’s a reason that agents exist, and why they get a big fat check when the property is sold.
You also need to really think about what the likely buyer for the home is, and what they expect to be provided with, and what they’d be thrilled to see in the house. Putting stainless appliances into a $30K foreclosure sounds like overkill to me, as this will be the first home for many buyers, and they’re going to be thrilled to simply own a house. Try to look at the things someone living in an apartment misses out on (a laundry room of their own, a backyard, a garden, etc.) and don’t get bogged down with tricking the house out with granite and stainless steel appliances.
In general, don’t rush into any decisions. I definitely understand the desire to get started, and eargerness is going to serve you well, but in all likelihood this house isn’t going anywhere soon, and there will always be another house, even if it did get snatched up. You’re almost guaranteed not to get a loan for the purchase price + renovations, but talking to your contact at the bank is a good idea. Talk to agents, talk to brokers, talk to anyone that will listen to you. As much as you’d like to, you can’t do everything yourself, so the sooner you start networking, the sooner you find good people that can help with some of the heavy lifting.
yea, i might look into selling through a real estate agent, but i might have it for sale about a month or two on my own first. If i don’t get any bites, I’ll go from there. It took me about 3 days to find the house actually listed when i was looking for it specifically by address. I think if i place an ad in the paper for a while maybe people will actually see the darn thing. I can’t believe how awful of a job the real estate company is doing in promoting the house. (but it might be good for me, lol)
As far as the stainless steel…I have priced things at the store I am going to buy from and I can get stainless steel things for the same price or just a few dollars above plain old white things. They have a stainless steel range with a lower cooking drawer, glass top, and digital display for only $409.98 So i think it’d be worth the extra cash to throw that stainless stuff in, It would appeal to a larger crowd and be something that anyone would love about the house.
As for granite…I completely agree with you on that one. I dunno if I could ever make myself do granite even in a nicer flip house. I will most likely go with some “simulated” granite I found at another local store. It looks pretty close to the real thing for just a whopping $10 a foot, it looks amazing.
And since there’s a pretty good chance you’re right about me not being able to get a mortgage+renovations loan, do you think I should try getting a loan from a hard money lender? I have never heard of such a thing…any references? any downsides (besides incredibly high interest rates I’m guessing)?
Again, thanks for all the help Seth. I appreciate it.
Justin,
Hard money lender is just a fancy term for a private lender. Someone who has money sitting around and who is comfortable loaning it to people who can’t (or don’t want to) get a loan through normal means, such as from a bank or mortgage lender.
Most hard money loans are to people with less than stellar credit, but some investors with perfect credit use hard money loans as well, mainly because they can get a loan for the full amount of purchasing the house, closing costs, and renovation costs. Hard money loans are almost always higher interest rate loans, but they’re usually not insanely high. I’m just guessing, but you’d probably be looking at something in the range of 12-15%.
Finding a hard money lender is the hard part, as they don’t really advertise and you can’t look them up in the yellow pages. I’ve never gone this route personally, but in doing research I’ve seen people recommend talking to the following sorts of people, if you’re looking for a local hard money lender:
Accountants (if someone has enough money lying around to be a hard money lender, they likely have an accountant, who can possibly put you in touch with a client who does hard money loans.)
Lawyers (hard money loans involve drawing up legal agreements and contracts, so again, lawyers may have worked with hard money lenders in the past.)
Real estate agents (ditto the above, as far as past experience working on deals that involved a hard money lender as the financing source.)
Thanks Seth, now that you mention that I think I may know someone. There is an old man my dad knows that used to give out loans to everyone at a pretty fair interest rates back in the day. He gave people loans for cars, land, houses, and other things. I remember my dad saying about a year ago that he stopped loaning money for anything but real state because if someone can’t pay, he has something with a little bit of value. I guess he is a hard money lender…or the loan shark of my little town. I am going to go to the bank today and TRY to get a loan for all of it and if it doesn’t work, I might give him a call.
Once again, thanks for all of the advice. I’ll keep you informed of how everything works out.
BTW, are you guys on any kind of forums for flipping houses? If so, i’d like to join em. Thanks
Hard money lenders used to loan based solely on the property;s ARV, but now it seems they want all your credit info just like a bank. I use http://www.BrookviewFinancial.com which finances up to 75% of ARV including rehab costs.
Also, might want to consider using a flat fee listing service to get your home in the MLS. This is hybrid between FSBO and full MLS since you only pay one-half the commision
I’ve flipped 2 homes so far, but they were homes that I actually lived in for a while, renovated and than flipped (and moved into another fixer upper). Made some real good profits. Now I want to actually flip a home without living in the home. Just wondering how I will be taxed on this?, as it will not be my primary residence.
Any info will help!
Fred,
For a flip that’s not your principal residence, you’re going to get hit with capital gains taxes on any profit you make (something the myriad of house flipping shows on television never bother to mention). Here’s a quick overview of the various capital gains rates:
http://www.bankrate.com/brm/itax/tips/20010305a.asp
Depending on how long you own the property, you can also possibly do a 1031 exchange, assuming you’re in a position when you can re-invest all of the profits in a new property. 1031 exchanges aren’t
t good for quick flips, though, as the IRS frowns upon that, and people recommend you hold the house for 1-2 years minimum before pursuing a 1031 exchange.
Justin, I too am 18 going on 19 looking to flip my first house. I was wondering if theres anyway I can contact you, instant message, email anything like that. Were probably kind of in the same boat as far as how were starting out, so it would be cool to bounce back stories and info of what were doing.
Hey people,
Great to find this blog, hope to learn some stuff. Quick background…23 years old. Real estate agent and soon to be general contractor (test in a couple months!). I am a good amount of knowledge in both sides of the fence, yet I know i have a long way to go. So here is my question, hope someone can answer it. I am at the end of negotiations in a home in Los Angeles and are about to enter escrow. I will be putting about 65,000 down and the rest will be owner financing (150,000 left). The house needs a lot of rehab and the owner quite too old to get involved in it. Anyways, I plan to start a company at one point for flipping houses but will also try to hold some other properties for some positive cash flow. Real estate to rent and other to flip. As for tax purposes, what would be best, buying this home as myself or set up a corp. for it? I heard you can write off more stuff if it is a corp, but wouldnt I be taxed double once the gains go to my corp then is paid out to me? perhaps it is best to just take title as myself and just pay the tax and continue? especially since it is my first one? Any advice would be great!