Seduced by the possibility of huge cash returns or long-term passive income, more and more people are dropping their remote controls and jumping head first into the property investment game. But for those looking to augment their income or begin a second career as a real estate investor, understanding industry terminology and funding processes are necessary first steps. Despite all the buzz surrounding fixer upper real estate investors, it’s not the case that most front all the cash needed for their projects from their own bank accounts. The truth is that many utilize hard money loans to fund their projects.
What is a Fix and Flip Property?
Fixing and flipping a property begins with an individual (investor) purchasing a distressed or run-down property at an affordable price with the intent of renovating and immediately reselling for a profit.
What is Hard Money?
Funding for real estate investors exists within two categories: soft and hard money. Hard money, which is also known as a bridge loan or a short-term loan, is much easier to obtain than a standard bank loan. Financing is based solely on the deal or value of an investment property rather than an individual’s credit background or lack thereof.
Approval for a fix and flip loan may take less than 48 hours and funds may be available in three business days or less. To compensate for such a quick and easy loan process, they typically have terms that range from six, nine and 12 months (depending on the amount needed), interest rates as high up to 18 percent, and origination fees between two, three, and four percent. Funds for short-term construction loans can also be dispersed in several large increments over the course of the designated loan term. However, to receive these type of construction funds, a draw request must be submitted and the lender may require an estimated cost of repairs and/or a renovation plan to be presented after the investment property is purchased.
What are the advantages of Fix and Flip Loans?
Fix and flip real estate investors may look glamorous on TV, but what they don’t show you is the steps taken for purchasing an investment property. Like most of us, they don’t usually have hundreds of thousands of dollars just sitting around in their bank accounts. In fact, the biggest obstacle for new investors isn’t the work required for property renovations but rather securing the funds to acquire their investment properties in the first place.
In the real estate investment game, the best deals are gone fast! This makes hard money fix and flip loans so advantageous for investors. Lending from a traditional bank is never as simple or fast as one would think. Banks require all sorts of personal information: credit scores, bank statements, tax returns, proof of employment, etc. And if the bank unexpectedly approves financing, the desired property is most likely gone due to the extended time-frame it took to get the funds.
In contrast, most hard money lenders only require a few pieces of documentation and can award borrowers with a short-term loan within two or three business days after submittal. This streamlined loan approach is based on the after-repair-value (ARV) of the property, rather than the individual or requester, and grants borrowers the best chance to attain their desired property if they’re embroiled in a tough housing market.
And don’t worry how neglected the property is. Single family, multi-family, and commercial properties in various states of disrepair can qualify for various kinds of loans for flipping houses. With hard money lenders, approval rates for properties that are bank owned, in short sale, foreclosure, or in a distressed state are high. Traditional banks are averse to such properties and have strict rules in place as to what type of property they can accept as part of their loan portfolio. This is especially true if they are planning on selling the loan to Fannie Mae or another type of government loan program.
Local banks are also reluctant to fund the renovation of an investment property. Hard money lenders offer short-term rehab loans coupled with a fund reserve to provide timely funding for property repairs throughout the length of the established loan. This subtle loan tactic reduces stress for the borrower and allows builders and/or developers to complete rehab projects on time and within budget.
And finally, fees are another great benefit of hard money loans. Origination points are the only fees added with a typical hard money lender, and the points are usually tied in with their fix and flip loans. Since traditional banks rely heavily on years of interest payments, banks can easily slap borrowers who sell their homes and/or pay off their mortgages too quickly with pre-payment penalties. These penalties can greatly increase your out-of-pocket expenses and reduce your overall ROI from the flip.