Beginner’s guide to fix-and-flip loans
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Buying a rundown property, renovating it and then selling it for a profit sounds like a great strategy, but first-time investors often stall when it comes to financing for these projects. A regular mortgage isn’t built for this kind of deal, which is why fix and flip loans were created. They’re a separate category of short-term financing specifically aimed at renovation-and-resale projects.
What are fix and flip loans?
Fix and flip loans are usually short-term, running anywhere between six and eighteen months, and they’re built to cover the cost of buying a house and fixing it up so it can be sold at a higher price. That timeline is closer to the shelf life of a flip than the thirty-year length of a regular mortgage. Lenders who offer these loans tend to be private companies rather than big banks, and they care less about a client’s tax returns and more about whether the deal itself makes sense. In other words, the loan is asset-based, which means that the property and the numbers behind it get evaluated, not the person’s income history.
Fix and flip loans vs. traditional mortgages
Banks usually look at historical information, using W-2s, years of credit history, and tax returns, to decide whether a client is likely to be able to repay a loan for its entire term. A fix and flip lender looks forward instead, mostly at the ARV (After-Repair Value), or what the house should be worth once the renovation is finished. That number carries most of the weight in the approval, because the underwriting is largely focused on the deal itself and not the client’s personal finances.
Speed is another major difference between traditional mortgages and fix and flip loans. A bank mortgage can take a month or more to close, as a result of the volume of documentation that has to get processed along the way. However, fix and flip financing can close in a few days, in some cases, which is one of the most important factors for real estate investors who are looking at a good deal on a property and can’t wait around for a slow approval process.
How the numbers work
When it comes to fix and flip loans, two numbers drive most of the approvals: loan-to-cost (LTC) and ARV. LTC usually covers somewhere between 80% and 90% of the purchase price plus the renovation budget, so the client is still expected to put up some of their own cash. Lenders typically cap the loan at around 65% to 75% of the ARV, so they’re not overexposed if the resale doesn’t go as planned.
Renovation funds are released in draws, meaning the lender pays out portions of the renovation budget as work gets completed and inspected. Draws exist so that the lender can confirm that the cash is actually going toward construction, and so that the client isn’t sitting on a large sum of money without a clear plan for it.
Rates on these loans run higher than a standard mortgage, and there are usually points charged at closing as well. This is due to the fact that the loan term is short and the property is, by definition, unfinished, so the lender is pricing in a level of risk that a conventional thirty-year mortgage doesn’t need to.
Who qualifies?
Down payment requirements usually land somewhere between 10% and 25% of the purchase price, and first-time flippers should expect to be closer to the higher end of that range. Credit history is still a consideration, but less than it would be for a bank mortgage. Fix and flip lenders are more concerned with the numbers on the deal actually working and whether the renovation budget is realistic, given the scope of the project.
The type of property is also a factor when applying for these loans. Most lenders in this space focus on residential properties, meaning single-family homes and small multifamily buildings, rather than commercial real estate like a strip mall or an office building.
Benefits and risks
One of the main benefits of fix and flip loans is speed, which gives real estate investors the chance to act on good deals before they disappear, but that’s just the start. With fix and flip loans being built around the actual project, loan terms can be flexible enough to match what the deal actually needs. If a client needs a larger draw upfront for a bigger renovation or a shorter term for a quick cosmetic flip, these lenders can often adjust the loan terms around the deal. Approval also leans on the deal itself rather than years of income documentation, which opens the door for investors who might not qualify for a conventional mortgage but have found a property worth flipping. These lenders work in this space every day, so many can also offer guidance on the renovation budget or the after-repair estimate that a traditional bank usually wouldn’t be able to provide.
The risks revolve around timing and rates. These loans are short by design, so it helps to build a reasonable buffer into the renovation schedule rather than assuming everything wraps up exactly on time. It’s also important to factor in the higher rates that come with fix and flip loans, in comparison to traditional mortgages. However, for most investors, the tradeoff is worth it given the speed, flexibility, and deal-specific structure these loans offer.
Before applying
3 steps to take before applying for a fix and flip loan:
- Set a realistic renovation budget.
- Get an accurate ARV estimate.
- Make sure there are enough cash reserves to cover whatever comes up along the way, because something usually does.
The application process itself varies by lender, some lenders offer online pre-qualification with only a soft credit check, meaning it won’t affect a client’s credit score. It’s a good idea to check with each lender directly, to understand their process. Lenders who are experienced in this space, like New Silver, can walk a first-time investor through the loan process from start to finish.