With the DIY Network, reality TV shows and the seminars on real estate investing, I thought it fitting that I should post something about one of the opportunities that exist in this space. Plus, I have many friends and clients that have been asking me about Fix and Flip loans or investment real estate loans in general.
I probably should mention a couple of things early to dispel so of the myths. There is no real magic in the way the process works. This is not a no money down or get rich quick scheme. There are ways to lower your entry costs going into a real estate investment, but you shouldn’t expect to go into the deals with either no money or bad credit and especially with both, no money and bad credit. It can happen with no money and bad credit, but more times than not, those are the, “I wish that would happen to me” kinda deals.
Let’s set parameters so we are all on the same page. First, we are talking about single family residences (SFR). This can be either a “detached” SFR, a townhouse, a condo, a duplex or a four-plex. There are different rules or requirements for smaller apartment complexes, 5+ units. The other thing that is important to mention here is that this discussion is for investment properties only, not for a house that will be your primary residence. There are different programs for buying and fixing a property you plan to live in. Completely different topic than what I am going to address. Finally, I am approaching this topic from a mortgage lender/broker perspective, not a realtor and not a contractor or builder. The assumption you should make or the thought process you should have is, “what is it going to take for me to get a loan to do a Fix and Flip.”
Now with all the intro out of the way, I think the best place to start is a brief explanation of a “traditional” loan to purchase investment real estate, versus a Fix and Flip loan works. To purchase a rental investment SFR property using conventional financing requires 25% down, plus you will pay closing costs. For purposes of our conversation and as an example, I’m going to use the sales price of $115,000, only because I just had a deal with this sales price and all of the numbers are convenient. On this deal with traditional financing the down payment would be $28,750 and the closing costs are going to be around $6,000. Combined that’s $34,750 or about 32% of the purchase price, out of your pocket. Ouch! The great thing about a traditional loan is the interest rates are relatively low and you can get a term of up to 30 years which will make the payment lower.
Suppose you also need to repair the house. It’s broken, kind of. Assume you need floors, walls repaired, paint, some plumbing “stuff” like toilets, etc. Let’s say the total repairs are about $15,000. Unless you’re a handyman, that’s more money out of your pocket. Traditional loans for investment real estate don’t include any allowance for repairs. With the repairs your total out of pocket would be $51,750. I’m not going to talk about the appraised value and what you would make if you sold it. That’s just too much money out of your pocket, upfront!
Last thing about the traditional loan approach. The requirements are stringent. The minimum credit score is typically around 640 and above, although you may be able to get a deal closed with FICO scores as low as 620. There are requirements on debt-to-income ratio and a limit on the number of “financed” properties you can own.
Let’s look at same transaction using a Fix and Flip loan. I’m warning you, the fees are high, but forget fees and think about the amount of money out of your pocket. With any investment, real estate or other type investment, there are two primary things that most people consider: 1) how much is it going to cost me and 2) how fast can I get my money back? I guess there are really three with the final one being how much am I going to make?
Just as a primer, a Fix and Flip loan is a “hard money” loan. Some characteristics of hard money loans include: higher interest rates, high upfront fees, and shorter terms. In some cases, credit score is not a huge factor, although the higher the score, typically the better the terms. With hard money The primary consideration is the value of the property versus the amount of the loan. In a lot of cases your income is not even verified.
As a side note: there are many Fix and Flip lenders. There are subtle differences between the programs they offer, and the costs of the loans can vary dramatically. I am only going to use one example, not because it’s better, but because it’s the last transaction I did, and the numbers and terms are still fresh.
Back to our example. The purchase price was the $115,000. The house was broken: no floors, holes in the walls, AC didn’t work, needed painting, toilets busted, no closet doors and on and on. The repairs were estimated to cost about $15,000. The value of the house, after the repairs were completed was $168,000. This value is called the ARV or after-repaired value. This is important, probably the most important thing to know in Fix and Flip transaction. The value is an estimate that an appraiser gives before you buy the house and takes into account the repairs you plan to make. With the ARV being an estimate, the actual sales price may be higher or lower. You, as the investor, should do some research on your own to determine if the ARV is realistic by comparing it to other houses for sale in the area. Your research should include houses similar size and relatively close in proximity. The appraisal will include “comparable” houses that will give you a feel of how close the value will be, AFTER YOU DO THE CONSTRUCTION.
On a Fix and Flip, the amount the lender will lend is based on the percent of the ARV. With the lender used for this transaction the maximum loan was 70% of the ARV, up to 100% of the purchase price AND including whatever amount of construction that 70% of ARV plus the purchase price would cover.
Let’s stop and do some math before we resume this conversation. Take a look at the following table:
Purchase Price, $115,000
As Repaired Value, $168,000
Loan Amount, $117,600 (70 % of ARV)
Credit towards Repairs, -$2,600
Repairs Out of Pocket, $12,400
In this example, the loan is for 100% of the purchase price. There is also a credit of -$2,600 that will be applied towards the construction cost. Great deal so far, right? Let’s go a step further.
The construction cost balance, the $12,400 ($15,000 minus $2,600) must be put in escrow. It will be disbursed periodically as construction is completed. Assuming you complete the work cheaper than the $15,000 or sell the house before the construction is completed and you get the remaining in escrow back.
Let’s talk about the costs of the loan for a minute. Remember, the costs vary from lender to lender. In this scenario these are the loan costs:
Costs Description (Amount Paid to:)
Lender Origination (3%) – $3,528 (Lender)
Broker Origination (1-2%) – $2,352 (ValleyNMC)
Appraisal – $450 (Appraiser)
Survey – $400 (Surveyor)
Admin Fee – $500 (Lender)
Doc Prep – $500 (Lender)
Title Company Fees – $1,700 (Title Company)
Total Fees Out of Pocket $8,930
Interest Rate 14%
So, with this deal the total out of pocket would be $21,330, the $12,400 in escrow plus the $8,930 of closing costs. Not chump change, but compared to $51,750 it’s a pretty sweet deal. The beauty of this lender is that there were no income documents required. No pay stubs, no tax returns, etc. The client had credit and obviously the cash to put down with some remaining reserves. The other wonderful thing about his lender, there was no prepayment penalty, so the loan can be repaid with no additional costs.
This was an interest-only loan with payments due monthly.
Let me say this, if the house sells for $168,000 or above the client stands to make about $35,000. I am assuming some transaction costs to the client on the “flip.” Not a bad deal!
This is one example. There are many lenders and not every lender is a good fit for every situation. Working with a mortgage broker, like Valley National Mortgage Company LLC is a fantastic way to identify the right lender for your situation.
Valley National Mortgage Company LLC is licensed in Texas as a mortgage company by the Texas Department of Savings and Mortgage Lending and the Nationwide Mortgage Licensing System. The NMLS ID is 1084075. Marcus Nelson is the designated mortgage broker. NMLS ID 1088213. To contact Valley National Mortgage Company LLC visit our website at www.valleynationalmortgage.com or send an email to firstname.lastname@example.org