Are you interested in fix and flip projects but aren’t sure about your short-term financing options? Have you heard about hard money loans and want to know more about how they can benefit your project? Do you need alternative options to fund your flip?
Many real estate investors turn to private lenders to get the funds they need to purchase rental properties or distressed properties that they eventually flip back onto the market for a profit. If you want to learn more about your short-term financing options and their pros and cons, continue reading below. We will cover all you need to know about these loans and where you can go to apply for the best solution.
Hard Money Loans
Hard money loans, also known as bridge loans, are an excellent option for both new and seasoned investors looking to fix and flip properties. This type of short-term financing option has a “hard asset” backing the loan. In this case, the asset is the property that you wish to purchase for the fix and flip.
What is a Bridge Loan and How Does It Work?
As stated above, these loans use the property in question as collateral. Hard money lenders are more interested in the property’s value than the borrower’s creditworthiness. In order to get this loan, you must reach out to a private lender.
Fannie Mae or Fannie Mac does not regulate hard money loans because properties purchased with these loans are usually distressed and don’t meet the strict requirements set out by those entities.
Advantages of Hard Money Loans
One of the most significant advantages of using these types of loans is the ease of the application and the approval process. Once you find a reputable private lender, you will just need to submit your information to them.
They will need information about the property, your personal contact information, and the amount you wish to borrow. When reviewing your application, they spent less time verifying your income and reviewing financial documents.
Low Credit Scores Are Ok
Most private lenders don’t require you to have a high credit score before issuing an approval. The minimum credit score is 660, but each lender sets its minimum credit score requirements. Compared to traditional financing, conventional lenders typically require their applicants to have credit scores well into the 600s or 700s to receive decent interest rates.
No Prepayment Penalty
Unlike some other traditional loans, hard money loans have no prepayment penalty fees. If anything, your lender would prefer you repay the loan as soon as possible. Most of these loans have short repayment periods of between one to two years.
Disadvantages of Hard Money Loans
Although obtaining a hard money loan is relatively easy, there are a few disadvantages you should keep in mind. For example, hard money loans come with high-interest rates.
The interest rate for hard money loans is high because the lender has to mitigate their risk. Because these lenders have a more straightforward approval process that doesn’t involve stringent requirements, they have to make up for it in the interest rate. However, do remember these are interest only loans so the payment is lower.
Higher Down Payments
Another disadvantage of using a hard money loan is the down payment. Traditional loans such as conventional loans or FHA loans typically only ask for about 3.5% to 10% of the property’s purchase price. With hard money loans, you can expect to have to put down between 15% to 20% of the property’s purchase price.
Home Equity Line of Credit
Home equity lines of credit, also known as HELOCs, work similar to credit cards, but instead of receiving an unsecured line of credit, your home’s equity serves as collateral. With a HELOC, there are two different periods: a draw period and a repayment period.
How Does a HELOC Work?
Before you can receive your funds, your lender will need to appraise your property to figure out what available equity you have in your house. If your lender approves you for the HELOC, you can only borrow between 15% to 20%. You can use these funds for the entire duration of your draw period, which is about ten years. During the draw period, you only have to repay the monthly interest.
Advantages of HELOC
One of the advantages of using a HELOC is that you can use the funds as you need them. Even though you have access to a large amount of money, you don’t have to use it all at once.
Most loans provide you funds as a large sum as money, and once you use it all, you have to pay it back. With a HELOC, you essentially pay as you go. You can use the funds you pay back if you are still within your draw period.
Few Restrictions on the Funds
Although your home equity line of credit uses your house as collateral, you don’t have to use the funds for home improvements or something that pertains to your house. Instead, you can use these funds for your fix and flip project or for other expenses.
Disadvantages of HELOCs
Even though you have quick access to your home’s equity to use for your fix and flip projects or other expenses, your house is put up as collateral. This means that if you aren’t able to repay the money you borrowed, you risk losing your home.
Variable Interest Rates
Home equity lines of credit have variable interest rates. This means that the interest rate can change at any moment, including during your draw period and well afterward. Even if you took out the HELOC with a low rate, there is a chance that you could face high rates when it comes time to repay what you used.
Risk of Overspending
Because the HELOC gives you a long draw period to use the funds how you see fit, there is a risk you could overspend what you really need. Many homeowners think that they will be able to pay back the money in time, but sometimes they don’t.
If you miss making your monthly interest payment during your draw period, you risk shortening your draw period time frame. Your lender has the right to end your draw period if you fail to make your payments, and they will then ask you to pay the money you’ve borrowed.
Personal Loans
If you are looking for a quick short-term loan, you can reach out to a credit union or a local bank for a personal loan. There are also several different personal loans you can apply for online. Depending on who you decide to go through for your loan, you may or may not have to put up collateral.
How Does a Personal Loan Work?
Once you locate a lender you wish to use for the personal loan, you will need to send them your personal information in addition to your income information. Most lenders want you to have a decent credit score in the 600s before they authorize the loan.
Each lender has the right to set its own underwriting rules and interest rates, so be sure that you review the terms and conditions before you agree to anything. There are some lenders who practice predatory lending, which can lead you more in debt than you started.
Advantages of Personal Loans
One of the most significant advantages of using personal loans is the fact that you can use the loan for virtually anything. You can use it for fixing and flipping projects or debt consolidation. You can also use this money for improvements on the property if needed.
Competitive Rates
Granted, you have a decent credit score; you can look forward to receiving a competitive rate for your personal loan. The higher your credit score, the better your credit terms will be. This means lower monthly payments and lower interest rates.
Disadvantages of Personal Loans
Although personal loans are relatively straightforward to apply for and obtain, there are a few disadvantages you should be aware of. For example, personal loans will only qualify you for a certain amount that may not cover the amount you need for your fix and flip.
Possible Additional Fees
In addition to paying your monthly principal and interest payments, you may have to pay additional fees.
Examples of possible additional personal loan fees:
- Prepayment penalties
- Nonsufficient funds
- Application fees
- Late payment fees
Before you sign any documents, you want to ensure that you completely understand the terms and conditions of what you’re signing up for. If you are unsure, don’t hesitate to ask the lender about all the applicable fees.
How Much Does It Cost to Flip a House?
It is important to note that flipping a house is more than just finding a loan to finance the project. There are carrying costs, also known as holding costs, that you must keep in mind when determining how much you need for the project.
Holding Costs
You must pay holding costs to keep the property up and running.
Common carrying costs:
- Homeowners’ insurance
- Mortgage payments
- Property taxes
- HOA fees
- Property management
- Regular maintenance
In addition to these fees, you must also consider paying for the property’s utilities. This includes electricity, gas, and water. If the home is vacant, you may be able to get away with turning off the HVAC system, but it depends on where the property is located.
If the house is in an area that snows or the temperature dips below freezing, you will want to keep the HVAC system on. You don’t want the pipes to freeze because it will cause them to burst. You can set your home to 65 degrees as a buffer to prevent this.
For homes in warmer climates, you should also keep the system running. Not only does the air conditioning system keep the house cool, but it also prevents the growth of mildew and mold in humid areas of the country.
Marketing
When it comes time to sell or advertise the property as a rental property, you will have to pay for marketing. If you aren’t sure how to properly market the property, you may want to seek help from a real estate agent or a property management company.
Cost of Renovation
The renovation cost is one of the most significant areas of the flip that you must pay extra attention to. Not only do you have to have a loan large enough to cover the purchase price of the property, but you also have to consider the cost of the renovations.
What materials do you want to use? Do you plan on hiring a team to complete the work? Do you need an interior designer? How much will the repairs cost?
In order to help you plan out how much you will need for the entire project, you may want to create a business plan for the property. Business plans aren’t only good for starting up small businesses; they are also excellent for fix and flip projects. Most lenders prefer that you have a business plan available so they can better understand how you plan to use the funds from the loan.
Best Short-Term Financing Options
Many real estate investors love fixing and flipping properties, and when they need short-term financing options, they usually lean more towards a hard money loan, also known as bridge loans. Although there are alternative financing options, they have their own advantages and disadvantages that can limit or hinder your fix and flip project needs.
Contact us if you are ready to find out your bridge loan rate! Our team is here to answer any questions or concerns you have about the application process.
