If you’re new to real estate investing, you probably have a lot of questions. TV makes flipping houses look fun. Buying a fixer-upper and selling it for a project even seems fun. But those shows don’t typically shed light on how to get started with a house flipping business. How do you find a property to flip? Do you live in a bad state for flipping houses? Should you hire someone to fix up the house or go DIY?
Most importantly, how do you get the money to flip a house?
In this article, we’re going to walk you through the process of funding a flip. We'll show you how to get a loan for flipping a house. But first, to give you an idea of what you need to plan for financially, we’re going to touch on the general costs of flipping houses. Then we’ll explain the various funding options available.
The costs of flipping a house
The costs of a flip can vary, as there are several components that make up the total amount you will pay on a project. These costs can include:
- Purchase price and closing costs (property acquisition)
- Cost for renovating the house (material and labor costs)
- Carrying costs (interest on financing and financing fees)
- Marketing and sales costs
Although you can cut costs in some areas, such as performing as much of the labor yourself as you can, you should have a thorough vision for what the total cost of your flip is going to be before you start looking for funding. The goal for successful flippers is to turn a profit on each project, so being strategic is critical.
With all the costs in mind, it’s time to secure financing for your real estate project. Likely, traditional banks will be hesitant to loan you money for a house that won’t be your primary residence. Even banks that loan money for flipping likely prefer someone with a track record of successfully flipping houses versus a first-time flipper.
So where do real estate investors turn to cover their costs? Here are six financing options for house flippers to get the funding they need, including the details, pros, and cons of each.
Family or friend loans
- May be able to avoid costly interest and fees
- Fewer hoops to jump through
- Personal relationships could be affected
Turning to your family or friends to lend you the money for your real estate investment is definitely an option worth considering. If your friends or family are interested in investing in your project, this can be a great way to avoid many of the costly add-ons of borrowing money from traditional mortgage lenders. That said, there are some caveats you should keep in mind when using loved ones as private lenders.
Money and relationships don’t always mesh well. Borrowing money from someone with whom you have a personal relationship should be done with caution. What happens if your flip flops and you don’t have the money to pay back your friend? What if your family members get restless and demand you return the money sooner than you agreed? Are you prepared to have those discussions with loved ones?
If you’re going to borrow money from family or friends, treat it the same as a bank loan. Lay out the terms of the agreement in writing and abide by them. Throw in some incentive for them to want to invest in your project. This can be something as simple as insisting you pay interest on the money you borrow, even if your friend or family member doesn’t ask for it.
Pay an interest rate that’s comparable to the rate they could earn with a high-yield savings account. That way, the money isn’t treated as a gift, but rather a true loan. You never know, your friend or family member may be looking for ways to make money too. And although family and friends can be a great way to save on borrowing money, you don’t want to spoil these relationships in the process.
- Helpful if you can’t secure a mortgage
- Closing process is generally faster and cheaper
- You and the seller agree on a down payment
- You may pay higher interest
- You can still get turned down if you’re a credit risk
- Seller financing is less common than traditional methods
Seller financing is when the buyer has a loan agreement directly with the seller of the property, instead of going through a financial institution. This can be useful if you’re having trouble getting a loan due to bad credit or because you have less cash available for a down payment.
Sellers may also have less rigorous requirements when it comes to flip financing. Because a bank isn’t participating in the transaction, you will generally encounter fewer closing costs as well. You can avoid the cost of mortgage points (fees paid to the lender during closing to reduce the interest rate), origination fees, and other charges often associated with lender financing.
In this scenario, the seller takes on the role of financier, extending you enough credit to purchase the home. In most cases, you will sign a promissory note to the seller detailing the interest rate, repayment schedule, and what happens if you default on your loan. Then, you pay back the loan over time as you would with a traditional lender.
Typically, the idea is that in a few years, when the home has gained enough in value or your financial situation has improved, you can refinance with a traditional lender. Because you may be paying higher interest than you would with a traditional mortgage, refinancing is often a good idea.
Home equity loan or line of credit
- Interest rates are generally lower than hard money loans
- Financial flexibility
- Interest payments may be tax deductible
- Your home is your collateral
- The amount you can borrow depends on your home’s value (and other factors)
If you’ve built enough equity in your home, you may want to consider tapping into it to fund your house flip. Equity is the difference between what your home could sell for and what you owe on the mortgage. You can use this equity to fund a flip in a couple different ways:
Home equity loan
A home equity loan is a type of loan that is backed by your home. In other words, you use your home as collateral. Should you default on your loan, the lender could foreclose on your house.
For the most part, interest rates and payments are fixed with a home equity loan, so your monthly payments won’t fluctuate. You can usually borrow up to 85% of your home’s value; however, the exact amount of money you can borrow will depend on factors such as your income, credit history, and how much your home is worth.
For example, say you have a home with a market value of $350,000 and you have a remaining balance of $200,000 owed on your first mortgage. Your lender has said they will allow you to borrow up to 85% of your home’s value. That means you can borrow up to $97,500. Here’s how to get that number:
- $350,000 x 85% = $297,500 (the total maximum of what you can borrow)
- $297,500 - $200,000 (the amount you owe on your mortgage) = $97,500
Using this example, that’s $97,500 you could put toward funding your flip.
Home equity line of credit
A home equity line of credit, also known as a HELOC, is a revolving line of credit that is also secured by your home. It resembles a second mortgage but functions much like a credit card in that you have a credit limit you can tap into whenever you need it. HELOCs can be used for anything, which makes it a suitable funding option for flipping houses. You use the credit you need and make payments only on the amount you borrow.
Similar to a home equity loan, you may be able to borrow up to 85% of your home’s value. However, unlike a home equity loan, HELOCs usually have variable interest rates similar to a credit card. As a result, your interest rate can change month to month depending on U.S. economic trends. This can lead to lower payments one month and higher payments the next.
Closing costs and fees vary by lender for both home equity loans and HELOCs. These can include, but are not limited to appraisal fees, origination fees, notary fees, and title search fees. Some lenders might not charge closing costs and fees at all, so comparison shopping is always a good idea.
- You’re borrowing your own money
- Approval is easy
- Low interest rate (which is paid to you, not a bank)
- May be required to repay loan in full if you leave your job
- Unpaid amounts (according to the loan’s terms) become a plan distribution, which can result in a taxes and penalties
- You’re jeopardizing your retirement
- You’re double-taxed
Tapping into your retirement funds to finance a flip is another option, though it has upsides and downsides. A benefit of using a 401(k) loan to fund your flip is the easy approval process — as long as your plan permits loans, you can borrow against your account.
For a traditional 401(k), the repayment process is hands off. You repay your loan through payroll deductions as long as you are employed, which helps reduce the possibility of falling behind on your payments. If you’re self-employed, you just need to set up a payment schedule for your solo 401(k).
Your 401(k) loan agreement will spell out the principal, loan term, interest rate, and any fees that apply. The IRS limits the amount of money you can borrow from your 401(k) or solo 401(k). The maximum amount will be the lesser of $50,000 or 50% of the amount you have vested in the plan. Depending on the cost of your flip, the maximum amount you can borrow ($50,000) may be enough to cover the renovations of your flip, but not the purchase price.
Your vested amount is the amount you own in a retirement plan, and you also always own 100% of your contributions. Company matching funds usually vest over time. So if you’re 100% vested in your account balance, you own 100% of the funds — both what you contributed and what your employer contributed.
The normal loan length for a 401(k) loan is five years. This is the longest repayment period the government allows. You may be able to arrange for a shorter repayment term with your 401(k) plan administrator.
Pulling from your retirement savings to fund your flip isn’t always the best idea. By withdrawing your money, you not only lose out on retirement savings, but you also put your retirement in jeopardy. The risk of losing money on your flip may not be worth your financial future.
- Quick, easy process
- High loan amounts can provide more flexibility
- Loan terms are dependent on your credit history and income
When you take out an unsecured personal loan — an unsecured loan is issued solely based on your credit worthiness, without putting up collateral — you can typically use the funds for just about any purpose. This includes financing flipping a house.
The primary factors that determine whether you’ll qualify for a personal loan are typically your credit score and your income. The lender will use this information to assess your ability to repay the loan and this will affect the terms of the loan, such as the interest rate, how much you can borrow, and for how long. If you have strong credit and adequate income, you shouldn’t have much trouble getting favorable loan terms.
The amount of money you can borrow will vary from lender to lender but can range from $1,000 up to about $100,000. Keep this in mind when searching for the best personal loan so you can get the full amount of funds you need to cover your real estate project.
If you can’t secure enough funding with one personal loan, you may consider taking out several loans to fund your flip. Although average interest rates for personal loans are currently around 10%, according to credit reporting company Experian, rates can vary widely from lender to lender. Your actual rate depends upon credit score, loan amount, credit usage, and other factors.
Online lending makes it a breeze to get a personal loan. There are a number of online lenders to choose from, each with their own benefits and drawbacks. In many situations, you can be approved in a matter of minutes, with your funds deposited into your account within just a few business days — sometimes within 24 hours.
Hard money loans
- Can be a quicker solution to financing, as it requires less hoops to jump through
- Perfect credit scores aren’t usually necessary
- Loan terms may not be ideal
- The loan is collateralized by the underlying property or another hard asset
- Higher interest rates and fees compared to traditional loans
If you can’t qualify for traditional financing to fund your real estate investment, a hard money loan might be a solution. These types of loans are primarily used in real estate transactions, in which the underlying property or another existing property is often used as collateral. Lenders are typically individuals or companies advertising themselves as hard money lenders, but not traditional banks.
Hard money lenders typically have an understanding of local real estate markets and don’t require you to jump through as many hoops as traditional lenders in order to secure funding, making them a quick solution for financing. But although hard money loans are usually easier to get, they often come with higher interest rates and fees.
These types of lenders primarily consider the property you’re flipping or another underlying asset more than they do your income or creditworthiness. For a house flip in which the flip property is used as collateral, hard money lenders will inspect the property and make a decision after determining whether the property is worth owning. Should you default on the loan, the hard money lender will take ownership of the property. The inspection process usually includes an appraisal, survey, and home inspection to rule out hazardous conditions. Other considerations may include your plan for the property and even the neighborhood of the property.
Alternatively, if you have significant equity in an existing property, a hard money lender may provide a cash-out refinance loan. A cash-out refinance loan pays off your existing mortgage, resulting in a new mortgage. Although this can give you access to funding, be aware of the risks of using an existing property such as your primary residence as collateral.
Familiarizing yourself with the various means of financing your real estate project is the best way to determine which funding method is right for you. For some, a 401(k) loan may not be feasible; for others, a home equity loan is the best move to make. Thinking outside what you’re familiar with can be valuable when it comes to being a successful flipper and finding the best flip loans. Maybe you even have enough credit card rewards saved up to buy an investment property with points.
In all reality, it’s important to remember that you could lose money on a flip. As with any investment, do your research to minimize the downside. If you cover all your bases, you’ll have a much better chance at your flip projects being a success.