If Tarek & Christina can do, I can do it!… right?
Yes. You. Can! The number one question that I get regarding real estate investment is, how do I pay for it? I’m going to break down three different ways you can finance and manage your 1st flip.
First, what is a real estate flip?
It’s just the act of buying a home that needs work, usually a deeply discounted price, then doing the renovating and updating in order to sell it in excellent condition for full market value.
Style 1 – Slow and Steady.
This is generally deemed the safest and sometimes most profitable way to do a renovation project. In this slow and steady method, you purchase the home as an owner occupant.
You use conventional financing methods such as a conventional, FHA, USDA, or VA loan (whichever you qualify for and determine to be the best option for you at the time).
For this option to work to your full advantage, you would then move into this home. You may do some basic things to make it livable but you’ll move in pretty soon after purchasing it.
The benefit to doing so is that better loan options are available to you as an owner occupant. Additionally, you have some big tax breaks if you live in the house for at least two years prior to selling it. You’ll want to confirm the details with your tax professional but in most cases, you won’t have to pay capital gains taxes on the profit if you live your home for 2 of the 5 years prior to selling. Again, you’ll want to confirm the details with a tax professional pertaining to your specific situation to make sure you understand the benefits clearly.
Once you move in, you can get started with making the repairs and updates as you are able. If qualified, you can do some of the work yourself to save money. You can purchase items as you are able. There is no rush or pressure to get the project completed by a certain time.
This style of flipping is great for your first time because it comes with the lowest risk, you can take advantage of owner occupant benefits when it comes to your loan and tax incentives, and make repairs and upgrades on your timelines and at your convenience both in regards to schedule and finances.
These conventional loan options do have condition requirements. Not all distressed homes will meet these guidelines. This could reduce the number of options that you have but should not sway you from considering this option since it does have many perks.
Style 2 – An “investment” property.
If you’d like to use conventional loan options but you won’t be living in the home after you purchase it, this could be the way to go.
Investment loan options are similar to owner occupant loans in that they still have condition guidelines and many of the same loan term features. They do generally require a higher down payment and come with a higher interest rate. With this option, you will need to account for a down payment in the 15-25% range, in most cases.
You’ll also need to account for closing costs which may or may not be subsidized by the seller.
You’ll also need to have a plan for covering the renovation costs. Since you are not living there, there is a bit more pressure to complete the job quickly so that you can get it back on the market, recoup your investment and not have to make too many mortgage payments. A few things to consider:
- You’ll have to pay the down payment and any closing costs
- You will need to have a fairly good idea of the renovation costs prior to purchasing so that you can plan for how you will pay for them. A few ideas would be:
- Savings or investments
- Credit cards
- Due-At-Closing agreements
- Line of Credit
- Personal Loan
- Equity Loan (similar to a line of credit)
- If you close at the beginning of the month, your first mortgage payment won’t generally become due until the 1st of the following month. So, for instance, if you purchase the home on August 1st, you won’t have a mortgage payment until October 1st which gives you 2 months without making a payment.
You’ll still want to consider the fact that this option will have some limitation due to loan condition requirements. You’ll want to look for a home with mostly cosmetic issues and not structural or safety issues.
Style 3 – Rock & Roll – A hard money loan.
A hard money loan is typically a loan that is given by an investment group. The terms are vastly different from conventional loan types. These are groups of investors or financing institutions that pool their money to loan it out to people that can make them money on home renovations.
They will want to see that you have money, decent credit, and can follow through on your plans. Each company has different criteria and different things they will require of you in order to qualify.
These loans will generally cover 70-75% of the initial sales price of the home and all or part of the renovation costs. This option, for those that qualify, can significantly reduce the amount of funds that you have to have on your own.
They cover large portion of the total expenses but there are drawbacks. The loans have short terms, often only 12 months before payment is due in full. So, the pressure is on with this option. They want their money back quickly, with interest and fees, so they can keep re-investing it.
The rates and fees can be high but are sometimes worth it to have to put less cash out and find ways to pay for everything. With this option, you don’t have to worry about going slow and paying for things over time, using credit cards, or opening lines of credit, but you do have to consider that you have investors that are monitoring your progress and “looking over your shoulder” to make sure their money is coming back to them. This is a higher-pressure option but offers less upfront investment which makes it possible for some when it wouldn’t have been otherwise.
Please keep in mind that every loan option that we’ve discussed has qualification guidelines and requirements that must be met in order to qualify. This can only be done by completing the application process through a lender. If you need a recommendation, let me know and I’d be happy to connect you to the right person.