Everything to know about fix and flip loans

A fix and flip, also known as house flipping, refers to buying a property at a lower price, renovating it, and reselling it for a profit. Generally, investors buy a property that is undervalued or in need of repair, and “flip” it into a modern, updated home that’s ready to hit the market. Of course, renovating a house can require a large amount of capital. That’s where fix and flip loans come in.

How do fix and flip loans work?

Definition and purpose

A fix and flip loan is a short-term financing solution investors can use to buy and renovate a residential property with the intent to sell it for a profit.

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The loans are a type of small-business loan investors use to pay for buying a property and renovating it.

Key features and characteristics

• These are short-term loans – typically 12-18 months.
• The collateral for the loan is the property investors plan to flip.
• Typically, there is no penalty for paying off the loan balance early. 

How it works

Lenders structure fix and flip loans as term loans or lines of credit. Investors who have a business plan, good credit score, and past success in the industry are more likely to qualify for a fix and flip loan.

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Lenders determine how much investors can borrow by using calculations like a loan-to-value ratio, loan-to-cost ratio, and after-repair value.

1. Loan-to-Value Ratio (LTV) — This ratio compares the loan amount with the property's market value. For instance, if the maximum LTV for a fix and flip loan is 75%, then for a property worth $200,000, the loan could be $150,000 at most.

2. Loan-to-Cost Ratio (LTC) — This ratio compares the loan amount against the total project cost. So, if a project costs $150,000 (including purchase and renovation), and a lender offers 70% LTC, the loan would be for $105,000.

3. After-Repair Value (ARV) — This metric is just as it sounds. It represents the estimated property value of a project after an investor completes renovations. Lenders use this to determine loan amounts. For example, if they offer a 60% ARV loan, a property expected to be worth $300,000 after repairs would be eligible for a maximum loan of $180,000.

What are the requirements for a fix and flip loan?

For most fix and flip loans, the requirements are:

• A good credit score
• A business plan
• A specific property in mind

Types of fix and flip loans

There are a few different ways to borrow money to flip houses.

Hard money loan

How it works

Hard money loans are a nontraditional option. Investors using hard money loans borrow cash from another private investor or a company. These loans are more accessible to borrowers with poor credit, but they typically have higher interest rates.

Pros

• Hard money loans can close quickly, sometimes in a matter of days.
• It’s easier to qualify for hard money loans with poor credit.

Cons

• Hard money loans usually have higher interest rates than other types of loans.

Best for 

Hard money loans prioritize your property's potential and are open to borrowers with lower credit scores, making these good fix and flip loans for beginners.

Personal loan

How it works

Because personal loans are unsecured loans, the lender relies on your credit history as evidence you’ll likely pay back the loan. Personal loans have terms ranging from two to seven years, and interest rates vary based on your credit history and other factors.

Pros

• Personal loans do not require collateral.

Cons

• Personal loans usually require a higher credit score to secure a competitive interest rate.

Best for 

Personal loans are a good option for people who have good or excellent credit scores and need a smaller loan amount and a longer term than a fix and flip loan will provide.

401(k) loan

How it works

If your retirement plan allows loans, you can use your 401(k) to finance your flip project. With this type of loan, you are essentially borrowing money from yourself. The downside is if you don’t repay it on time (usually within five years), you could incur penalties and fees.

Pros

• It’s relatively easy to get approved for a 401(k) loan since you’re borrowing from your own retirement account.

Cons

• If you’re unable to pay your loan back, you may lose out on investment gains in your retirement fund.

Best for 

A 401(k) loan might work if you have no other options; however, you risk your future retirement if you’re not able to pay it back.

Business line of credit

How it works

Established house flippers may use a business line of credit to fund their flip. A business line of credit gives you access to a specific amount of money you can draw from as needed.

Pros

• Instead of taking out a large lump sum of cash, you can withdraw funds as needed.

Cons

• You need a good credit score and evidence of solid business financials to qualify.

Best for 

Because of the flexibility a business line of credit offers, this loan is a good option for experienced investors who only need to borrow money for a project as needed.

Seller financing

How it works

Another option is called seller financing, which is when a property’s seller acts as a lender. Like other loans, when a seller offers financing, the borrower repays it with monthly payments. 

Pros

• Seller financing is easier and quicker than traditional loans.
• Because the terms of seller financing are between buyer and seller, they’re more negotiable.

Cons

• Typically, these loans are shorter-term than traditional mortgages and have higher interest rates.
• Seller financing is not available for most properties. 

Best for

Seller financing is best for flippers looking for a more direct financing route, particularly in cases where they might not qualify for standard bank loans.

Home equity loan/HELOC

How it works

HELOC stands for Home Equity Line of Credit. This product enables you to borrow against your property. HELOCs and home equity loans allow you to access up to 80-85% of your property's equity. With a line of credit, you can access the funds as needed. With a home equity loan, you get a lump sum and make set monthly payments.

Pros

• You can tap into the equity you already have at competitive interest rates.
• With a HELOC, you can access money as needed.
• With a home equity loan, you have predictable monthly payments.

Cons

• You could lose your house to foreclosure if you can’t make your payments.

Best for 

Homeowners who have significant equity in their homes are good candidates for these loans. Additionally, they should have backup funds if their flip is not profitable to ensure they make their payments on time. 

Home Equity Investment (HEI)

How it works

A Home Equity Investment (HEI) is a financial arrangement where homeowners get cash in exchange for a percentage of their home's future value. Homeowners don’t have to make monthly payments. Instead, they share part of the home's appreciation when it sells or when they are ready to repay the investment. 

Pros

• HEIs offer immediate cash access without monthly payments.

Cons

• In exchange for cash, homeowners give a portion of their equity, which might mean they earn less profit when selling the home in the future.

Best for

An HEI is ideal for flippers who want access to money without having to make monthly payments.

How to get a fix and flip loan

Understand your needs

Cost and project timeline

It’s important to put together a business plan that explains how your fix and flip project will profit. Your business plan should include the following.

1. Cost – Put together an accurate estimate of the renovation costs, including material and labor. 
2. Timeline – After examining the extent of the renovations needed, you should also be able to estimate the timeline for the work.

Evaluate your qualifications

If you’re new to house flipping and have limited construction knowledge, you’ll likely have to pay more for labor than an experienced contractor.

Assess your financial situation

Having a good credit score can help mitigate your risks when house flipping. Lenders will also provide better interest rates to those with excellent credit scores.

Shop around for the right lender

Finding the best lender is also paramount. You want a company with competitive interest rates and excellent customer service.

Submit your loan application

Gather your documents before you submit your loan application. These include your last two years of personal and business tax returns, your business plan, and any evidence of previous success with fixing and flipping investment properties.

Final thoughts

There is a lot of potential for making a good profit with house flipping, but it requires dedication, skill, and a deep understanding of the market. Aspiring investors should leverage resources like online communities and professional networks to improve their chances of finding a good property investment. If you need financing to flip a house, fix and flip loans can be valuable for real estate investors, but they aren’t the only way to finance a home purchase and renovations.

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