5 Crucial Questions to Ask Before you Flip Your First House
Thanks to the seemingly endless glut of home improvement TV shows like “Flip or Flop,” “Masters of Flip,” and “Rehab Addict,” it seems like flipping houses has become America’s favorite pastime.
But for the inexperienced, house flipping can be a dangerous and costly game. Make one wrong move, and that “great investment” can turn into a monumental mistake.
Don’t want your first flip to be a flop? Here are five questions you might never think to ask yourself, but totally should, before you begin flipping houses.
1. Do I have a great house flipping team?
Buying and flipping a house isn’t a one-person job; it’s a team sport, and you need to surround yourself with the right players. This starts with having a savvy real estate agent who can help you not only find a great investment opportunity but also negotiate a great deal on the property. Buy low, and things are already looking up!
You also need home improvement professionals who can guide you through the remodeling process and help you set a budget, determine what renovations to make (some yield a better return on investment than others), and solve any issues that crop up during construction.
Typically, you want to hire a general contractor, a person who's responsible for providing all of the laborers, building materials, and equipment necessary for the entire project.
2. How long will it take to flip this house?
Ideally, you want to buy a house that can be renovated within four to six weeks, says Bobby Curtis, a real estate broker at Living Room Realty in Portland, OR.
A short turnaround time will help you keep costs like interest and taxes to a minimum.
On average, homes take about 180 days to flip, according to ATTOM Data Solutions, curator of a nationwide property database. But flipping a house can take a lot longer. After all, there’s no telling what you’ll find when you start tearing down walls.
Mold could be lurking behind drywall in a basement, or there could be electrical issues beneath the surface, warns J.B. Sassano, president of Mr. Handyman, a national home improvement company based in Ann Arbor, MI.
Also, depending on the housing market, it may take you a while to find a buyer once the home is fixed up.
The moral of the story: Patience is more than just a virtue for house flippers—it’s a requirement.
3. Am I putting too much at risk?
Although there are a number of loan options for house flipping, many first-time house flippers stretch themselves too thin when it comes to how much of their money they invest in a project. Some even put their entire retirement savings or child’s college fund on the line. Not a great idea!
It’s important to truly assess your risk tolerance. Depending on where you are financially, you may or may not be a good candidate for flipping houses right now.
4. Can I think like an investor instead of a homeowner?
When flipping houses, you have to keep future home buyers in mind. While it may be tempting, the last thing you want to do is make home improvements and design decisions that reflect your personal tastes instead of what most home buyers want.
Be prepared to choose home features and housing materials that are classic and offer wide appeal. If you can’t commit to doing that, flipping houses isn’t the right endeavor for you.
5. Do I understand my loan options?
Unless you have a ton of cash readily available, you’ll need to borrow money to buy and renovate a distressed property. But obtaining a loan for a house flip isn't like getting a conventional loan for a home you intend to actually live in.
Most house flippers use a “fix-and-flip loan” that’s specifically designed for purchasing and remodeling homes. There are five types of fix-and-flip loans, and each comes with its own set of qualification requirements and pros and cons.
Hard-money loan: Sometimes called “rehab loans,” these are short-term loans intended for real estate investments. These loans are usually much shorter than traditional mortgages. Six months to one year is most common, but hard-money loans can go up to five years. Moreover, interest rates are considerably higher, typically ranging from 12% to 21%, and most hard-money lenders also charge 3 to 6 points upfront, where 1 point equals 1% of the loan.
There’s also a limit on how much you can borrow. Typically, hard-money loan lenders allow you to borrow about 60% to 75% of the property value you intend to purchase. So, if you’re looking at a $200,000 property, for example, the most you’ll probably be allowed to borrow would be $150,000, meaning you'd have to pay $50,000 upfront.
Cash-out refinance: If the value of your primary residence has increased, one financing option for your flip is a cash-out refinance. This lets you tap the equity in your home by refinancing your mortgage for more than you currently owe and taking the difference in cash. Your new loan will be the amount you still owe on your mortgage, plus the cash you wanted to take out.
So, say you had a $300,000 loan, on which you still owed $200,000. That would mean you had $100,000 in equity in your house. You could cash out $25,000 of that equity, and get a new mortgage for $225,000, to replace your existing $200,000 loan—and then put that $25,000 toward your house flip.
The drawbacks? You’ll have to pay closing costs—which average about 3% to 6% of the total loan—and if you’re refinancing to a higher mortgage rate, you could wind up paying more money in interest on your loan over the long run.
Home equity loan or line of credit: Both a home equity loan or home equity line of credit are financing options that let you borrow money using the equity in your home as collateral.
The big difference: a home equity loan provides you with the cash upfront, and you pay monthly installments over the length of the loan (like you do on your first mortgage). With a HELOC, you access the money in small chunks over the life of the loan.
Investment line of credit: Also called an "acquisition line of credit," an investment line of credit is similar to an HELOC—except it’s issued solely for buying investment properties.
This short-term financing option—with loans generally lasting from about 18 to 24 months—lets you borrow cash as needed, up to a predetermined loan limit. These loans are best suited for people who have experience flipping houses, since borrowers are underwritten and approved based on their demonstrated record of owning or flipping investment properties, and their financial wherewithal.
Crowdfunding: When using crowdfunding, or “peer-to-peer lending,” the funds are raised through the contributions of a large number of people, usually through the internet.
For instance, RealtyShares, a San Francisco–based company that finances investment properties in 35 states, gives house flippers access to more than 38,000 high net worth individuals who invest in a specific transaction for as little as $5,000. RealtyShares funds up to 70% of the estimated after-repair value of a property in as little as 10 days. Interest rates vary from 8% to 11%, with the average loan term on luxury flips being 12 months.
