Tapping Your Own Resources for Cash

The logical first place to look for cash is to yourself. You probably won’t find enough money to flip a house by emptying your pockets or your purse or looking beneath the cushions on your sofa, but you may have some money sitting in the bank gathering dust, equity in your home and in other possessions that you can unlock, or retirement savings you can put to use in creative ways without making it subject to income taxes and penalties.

In this section, I guide you through the process of taking inventory of the cash and other valuables you may be able to convert to cash to fund your house flipping venture.

Shaking your piggy bank

Chances are good that you don’t have an actual piggy bank, and if you do, it probably doesn’t have much in it. However, you may have some money stashed away in savings and checking accounts or rotting in certificate of deposit (CD) accounts. You may also have savings bonds stuffed in a drawer or a lockbox that people have gifted you over the course of your life. A few of them may have matured. See how much money you can scrounge up from what you already have on hand. It may not be much, but it could help finance repairs and renovations.

You need to have money to buy and renovate a property and additional funds — at least 5 to 10 percent of your total cost — to prepare for the unexpected, such as a furnace going out on you in the middle of winter. You may have enough cash stashed to cover the unexpected expenses.

Unleashing the equity of your current home

Your home is more than just a place to live — it’s an investment, perhaps the best-performing investment you have (or the worst, if property values in your area have dropped dramatically). As you pay down the principal on the mortgage, equity in the home grows (assuming the house appreciates). Equity is your home’s net worth — if you sold the home today and paid off the mortgage, equity is the money you would stuff in your pocket.

You don’t have to sell your home to pocket the equity. By refinancing the home or taking out a home equity loan, you can unleash the equity and use it (or a portion of it) as investment capital to finance your house flipping venture. I cover both of these options, along with the risks of unleashing equity in your home, in the following sections. Further on in this chapter, I show you how to work with banks and other lending institutions to unlock the equity in your home.

You don’t have to tap into the equity in your home to flip houses. Tapping into your equity can place your primary residence at risk, and if you and your spouse both sign the loan documents, you’re both at risk. If you’re uncomfortable placing your home and other possessions at risk, consider borrowing money from an investor instead; see the later section “Borrowing from a private (hard money) lender.”

Whether you borrow money from a bank, credit union, or private investor, you’re still personally responsible and liable for paying back that money unless your agreements say otherwise.

Recognizing the risks

In many ways, equity is funny money … or fuzzy money. Nobody really knows how much you can sell your home for until you actually sell it, so borrowing against equity is a bit risky. Before taking the leap, be well aware of the risks:

If real estate values drop, you may owe more on your home than it’s worth. If you have to sell it, you’ll end up selling it at a loss.
Unlike other types of loans, mortgage and home equity loans use your home as collateral. If you can’t afford the higher house payments on your new loan, you may lose your home in foreclosure.
If interest rates rise, refinancing at a higher rate or for a longer term results in paying more for your current home — potentially tens of thousands of dollars more — than if you had kept your old, lower-interest loan.
Frequent refinancing can cost you thousands in closing costs that may take you years to recoup.

Refinancing your mortgage

The easiest way to unlock a chunk of equity is to refinance your home, giving you a whole new mortgage, paying off the old mortgage, and leaving you the rest. Ideally, you refinance a mortgage not only to cash out equity for investment capital but also to snag a lower interest rate or shorter term, so you pay less interest over the life of the loan.

Suppose, for example, that you currently have a $200,000, 30-year mortgage at 8 percent with a monthly house payment of $1,467.53. You’ve owned the house for 10 years and still owe $175,000 on the mortgage. If you refinance for $250,000 (the home’s current appraised value) and take out a 20-year mortgage at 4.5 percent, now you have a house payment of $1,581.62, and you walk away with the $75,000 equity that was locked up in the house (the refinanced amount of $250,000 minus the $175,000 to pay off the old mortgage) to use as investment capital.

Well, that certainly looks pretty rosy, but what have you lost in the transaction?

You now owe $250,000 on your home and have no equity built up in it.
Your new house payment is $114 more than your previous house payment.
Over the life of the loan, you’re scheduled to pay $27,360 more than you would have paid by sticking with your original mortgage.

In short, you’re going to pay $27,360 over the course of 20 years to gain access to $75,000 now. But think of it this way — by putting your equity to work for you in successful flips, you can turn that $75,000 into far more than $27,360. In fact, you might make that much money and then some on your first flip!

Of course, you don’t have to unleash all the equity in your home. To build on the previous example, you could take out a 20-year, $225,000 loan at 4.5 percent, with a monthly payment of $1,423.46, freeing up $50,000 in equity, or a 20-year, $200,000 loan at 6 percent with a monthly payment of $1,265.30, freeing up $25,000 in equity. Your choice depends primarily on your comfort level and risk and debt tolerance. The more equity you leave in the house, the greater your cushion, but the less investment capital you have to work with.

When refinancing, take the following precautions:

Don’t refinance into a loan that has a prepayment penalty — a provision in the loan agreement stating that if you pay off the balance of the loan early, you have to pay extra. The amount you’re required to pay is usually a percentage of the balance at the time you pay off the loan or a certain number of months of interest. The purpose of a prepayment penalty is to ensure that the lender receives some compensation for its work.
Don’t refinance a fixed-rate mortgage into a new adjustable-rate mortgage. Adjustable-rate mortgages are unpredictable; you could get burned by a sudden increase in the interest rate and your monthly payments.

Taking out a home equity loan or line of credit

Taking out a home equity loan or line of credit unlocks the equity in your home without affecting your current mortgage:

A home equity loan provides you with a single chunk of money — a one-time payment to you.
A home equity line of credit enables you to borrow only what you need and pay interest on only what you borrow, making this option attractive for financing renovations. It’s sort of like a credit card, often with a lower interest rate.

When shopping for a home equity loan or line of credit, look for a lender that doesn’t charge closing costs. Some banks and credit unions even cover the cost of the credit report and appraisal.

Home equity loans and lines of credit often come with adjustable interest rates, which carry additional risks. If the rate jumps significantly, it could make the monthly payments unaffordable and place your home at risk of foreclosure. Consider the worst-case scenario. What’s the highest the rate can go, and how much would the monthly payment be at that rate? If there’s any chance you won’t be able to afford the monthly payments, don’t do the loan.

Taking out a home equity loan or line of credit may be a better financial choice than refinancing your current mortgage in the following situations:

The interest rate on your first mortgage is low compared to current interest rates. If your current mortgage interest is 4.5 percent, refinancing to a mortgage at 8 percent is probably a poor choice. Keeping that mortgage in place and taking out a separate home equity or line of credit loan may be a better choice.
You’ve been paying on your first mortgage for several years. With every payment you make, you pay more on principal and less on interest, so if you’ve been paying 15 years on a 30-year mortgage, refinancing now may cost you in the long run. Again, a home equity loan or line of credit may be the better option.
You can quickly flip the property you’re investing in and pay off the home equity loan or line of credit. Assuming the loan has no prepayment penalty, if you can unlock the equity in your home and then quickly pay back the money, you retain your home’s equity.

Home equity loans and lines of credit are almost always preferable to refinancing an existing mortgage, assuming you can get a low-cost, low-interest, fixed-rate loan or line of credit, because they’re reusable. That is, you can pay down the amount you owe on a home equity loan or line of credit and then have it to reuse for another project. When you refinance a mortgage, you replace it with a new mortgage that’s not reusable; after you pay it off, that credit is no longer available.

Cracking open your retirement nest egg

Newcomers are often attracted to real estate investments because they may result in a higher percentage return than stocks or bonds. In addition, real estate gives you more control over the performance of your investment. In the case of flipping houses, if you do it right and don’t fall victim to a burst housing bubble, you stand to earn 20 percent or more on each house you flip. You’re not likely to see that sort of return on stocks and bonds!

Because real estate is an investment opportunity that’s as legitimate as stocks and bonds, some real estate investors are choosing to structure their IRAs (or at least a portion of them) around real estate investments. In other words, you can convert your IRA into a self-directed IRA and use the money in your retirement account to fuel your flips. Consult your accountant and your personal finance specialist to determine whether this option is one you want to explore and to work out all the details if you choose to go this route. It’s risky, but so is the stock market.

I use a company called Equity Trust (www.trustetc.com). The people there are helpful, offer webinars, and try to educate you on how to use a self-directed IRA as a tool to buy and flip real estate.

Another way to use your retirement income to help fuel a flip is to borrow from it to get enough cash to make a down payment on a loan to fund the purchase and repairs. For example, if you’re applying for a $100,000 loan to flip a house and are required to put 10 percent down, you can borrow $10,000 from your retirement account to use for the down payment. You’ll have to make monthly payments on that $10,000 as you would for any loan, but then you could pay off the loan (reimburse your account) after you sell the property. The interest is paid to your retirement account, and you’re not required to pay taxes or early withdrawal penalties on that $10,000, so you’re really not losing anything as long as you pay back the loan in full. Consult your retirement plan manager or financial advisor for details and to explain any possible ramifications of borrowing from your retirement account.

Leveraging the Power of Other People’s Money

Many people have an aversion to borrowing money, and for good reason — it costs money to spend money you don’t have, and when you spend money you don’t have, you don’t have money to pay back the money you borrowed. It certainly does cause a lot of problems for some people.

However, very lucrative businesses and individuals have made their fortunes on borrowed money. The not-so-secret secret is to use that borrowed money to earn far more money than you’re paying to borrow that money. That’s called leverage. You use a little of the money you have and a lot of other people’s money (OPM) to make a much bigger investment than you could otherwise afford on your own. Do it right, and you can pay off the loan and pocket a handsome profit.

With house flipping, your goal is to move as much house as you can with as little of your own money as possible. If you invest $100,000 of your own money in a property, for example, and you flip it for a profit of $20,000, you make a 20 percent profit on your $100,000 investment. On the other hand, if you invest $20,000 of your own money, borrow $80,000, and sell the property for $120,000, you earn closer to a 100 percent profit, because you’re seeing a $20,000 profit on $20,000 of your money. (I say closer to 100 percent, because these numbers don’t account for interest on the $80,000 borrowed, holding costs, and so on.)

To look at it another way, suppose you have $100,000 to invest. Many people assume that using that $100,000 to finance a single flip is the smart thing to do because you avoid paying interest on borrowed money. However, by leveraging that $100,000 with borrowed money, you stand to earn a bigger profit. For example, you can combine that $100,000 with borrowed money to flip a higher-priced property — perhaps a $500,000 house that you know you can sell in the $575,000 to $600,000 range.

Borrowing money is always risky, but you have to take some risk to earn the big bucks. Throughout this book, I show you ways to reduce risk, but unforeseen events can undermine the best-laid plans. As a flipper, you need to decide for yourself whether the potential benefits outweigh the risks.

The following sections show you how to gain leverage by using other people’s money to finance your flips. And if you don’t have money, I show you how to convince private lenders to put up some initial investment capital to get you started.

Convincing a bank to finance your flips

Since the mortgage meltdown of 2008, banks have tightened their criteria for approving loans. However, they’re still eager to loan money. After all, that’s how they earn their money. You just have to be able to convince the decision makers at the bank that you can make the loan payments and pay back the loan on time with interest. The key is to earn their confidence in you.

To gauge their confidence in approving a loan, lenders look at your five Cs: collateral, character, credit, confidence, and cash flow:

Collateral is the property you intend to purchase. When you’re flipping houses and attempting to obtain loan approval before looking at houses, you’re not in a position to describe the collateral, but you can put together a plan that shows the price ranges of the houses you intend to purchase, appreciation percentages for the area, and how you plan to renovate and sell the properties for a profit.
Character is the way you present yourself to the lender. You need to convince the lender that you have the knowledge and resources available to profit from your investments. A strong plan and presentation can convince the lender that you have the right stuff.
Credit is your credit report, credit score, and credit worthiness (how much you can afford). A clean credit report shows that you pay your bills and aren’t over your head in debt. See “Checking and correcting your credit report” later in this chapter.
Confidence is the confidence you and the lender have that you can deliver what you promise. Pitching a solid plan can build the lender’s confidence. How you portray your project either gives the lender confidence in your abilities or sends the lender running to the hills.
Cash flow is your current monthly income minus your monthly expenses — the amount of money you have free each month to take on your project.

Before approaching a prospective lender, do your homework and draw up a business plan showing that you know what you’re doing. Here are a few ideas on how to proceed:

Show the prospective lender a sample of a property that someone else recently flipped in the area — for example, a property that the person bought for $80,000 on August 8 and sold for $146,000 on November 16. Convince the investor through your knowledge and enthusiasm that you can do the same.
Present a property you would purchase now if you had the money and explain how you would fix it up and sell it.
Tie up a property on paper (either through a purchase agreement or an option to buy) and present this property as an opportunity. It sounds risky, but it often works, and it definitely forces you to find the money to close on the deal! (Your agent or attorney can help you acquire the necessary paperwork.)

If you’re not comfortable drawing up a plan yourself, ask your agent and attorney for help. Not only can they assist you in creating a plan, but they can also point you in the direction of other lending institutions and private investors they know.

If at first you don’t succeed, try, try again. If a lender rejects your proposal or gives you the cold shoulder, figure out why, change your package or presentation, and give it another shot. When I first started, a lender told me no and explained that I didn’t have enough experience. I added my father, an experienced carpenter and builder, to my proposal and pitched it to the same lender, who eventually loaned me the money I needed. My perspective has always been that “no” means the person I’m dealing with doesn’t “know” enough information to say “yes.”

Passing the hat among friends and family

Charity should begin at home. If you have a rich Auntie Ellen who has a stash of cash she’s willing to invest, and you don’t mind calling in some favors, hit her up for the money. With family members, you may be able to get a short-term, no-interest loan, assuming you’re not considered the black sheep of the family.

Be very careful when considering borrowing from family members. A flip that flops can quickly turn family members and friends against one another when money is lost and loans can’t be repaid. Be very clear up front what’s at stake and the risks involved. Losing a close relationship over a real estate deal gone bad isn’t worth it.

Borrowing from a private (hard money) lender

Lots of people have money to invest and are disenchanted with returns on their stocks and bonds. Convince them of your ability to turn a profit flipping properties, and they just may provide you with the investment capital you need to get started.

Loans from private investors are often referred to as hard money loans — high-interest loans that typically require an upfront payment and scheduled balloon (lump-sum) payments. Hard money loans often finance the purchase of the property along with the cash needed to repair and renovate it. The property and any future improvements function as collateral for the loan. Banks, mortgage companies, other lending institutions, and private lenders often offer hard money loans. The drawback is that hard money isn’t cheap — lenders may charge two to three times as much in interest as banks and other lending institutions, along with 3 percent to 10 percent in closing costs.

The approach for convincing a private investor to loan you hard money is the same as the approach for convincing a bank to finance your flips. See the earlier section “Convincing a bank to finance your flips” for details.

You can often locate private investors (or private lenders) through the newspaper, real estate agents, and mortgage brokers; by attending landlord meetings or investment seminars; or by joining a real estate investment group and doing a little networking. Most private investors lend money through mortgage brokers because most states require that lenders be licensed.

Remain cautious of experienced investors, landlords, or real estate gurus who agree to loan you money only so they can sell you their dontwanners. As a house flipper, you typically look for properties that owners don’t want, but properties that these guys don’t want could be real lemons; otherwise, they would probably flip the properties themselves.

Partnering with an investor

Partnering with one or more friends or family members may be an option, especially if you have rich friends whose house flipping skills complement your own or if you have the skills and they have the money. With their financial backing and your combined knowledge and skills, you may be able to form a long-lasting and financially rewarding partnership. You may also consider taking on a partner in the following situations:

Your credit is damaged, and you need someone who has a better credit rating to help you secure the loan.
You can obtain a loan for purchasing the property, but you need a partner to provide funds for renovating it.

If you partner with someone for access to cash, you typically split the profits. Unfortunately, when you’re just getting started, your negotiating muscle is a little flabby. The person with the cash usually calls the shots. A 50/50 deal is about the most you can expect, but that can be overly optimistic. With each successful flip, you strengthen your position and eventually can offer the people who front you the money slightly more than what they can make by investing their money elsewhere, so you keep most of the profit. Early on, however, you may need to give your more affluent partner a bigger chunk of the profits.

Taking on a partner is like getting married, so if you don’t trust a person as much as you trust your spouse, you probably shouldn’t become partners. Great partnerships are rare, but when they work, they enable both parties to achieve more than they could achieve individually. All too often, however, a partner runs off with the cash, fails to pay the contractors, cashes checks made out to the water company or building supply store and pockets the money, files an insurance claim to collect for damages without your knowledge, or figures out some other way to pick your pocket.

If you partner with someone, have your attorney write up a contract that details the responsibilities of each party and how profits are to be divided. Need an attorney? Head to Chapter 4 for help in finding one.

Using Conventional Financing (for Longer-Term Real Estate Deals)

Technically, flipping is quick — you buy, rehab, and sell a house in a matter of weeks or months. But not everyone’s in such a big hurry, especially when they’re just starting out. You may want to take your time with your first flip to get a feel for how it’s done. Maybe you want to live in the house for two years, so you can avoid paying income tax on a good chunk of your profit. Whatever the reason, if you plan to take your time flipping a house, you may have other financing options — traditional financing, such as taking out a mortgage to buy the property.

If you’re thinking of going with traditional financing, you need to take a closer look at your credit worthiness and examine your financial position as carefully as any lender would examine it. Pretend that you’re the lender.

The following sections take a snapshot of your financial picture and highlight the details that lenders commonly consider before approving a loan. By identifying areas of improvement, you can airbrush out any imperfections to make yourself look as good as possible to prospective lenders.

Determining what you’re worth in dollars and cents: Net worth

Net worth is simply whatever money you would have if you sold all your stuff and then paid off all your debts, including your taxes. Officially, the equation goes like this:

Net Worth equals Assets minus Liabilities

A strong positive net worth indicates that you

Own more than you owe
Don’t borrow more than you can pay for
Can pay off a loan by liquidating assets, if necessary
Probably know more about net worth than you realize

To prove to a lender that you’re net worthy, type up a page that lists your assets and liabilities and presents your net worth. If you have a spreadsheet program or a personal finance program, such as Quicken, use the Reports feature to generate a net-worth report.

A strong net worth can help you borrow money at competitive interest rates, but a low or even a negative net worth is not a death knell. If you have a solid investment strategy and the energy and commitment to implement it, you can secure the capital you need to get started.

Checking and correcting your credit report

Good credit is gold. Without it, you have access only to your own money. With it, you can put other people’s money to work for you. Whenever you apply for a loan, the lending institution performs a credit check — sort of a background check to make sure that you’re not up to your gills in debt, that your income covers expenses, and that you pay your bills on time.

To ensure success at obtaining loans, become proactive. Check your credit report every three months or so, correct any errors, and take steps to improve your credit rating, as instructed in the following sections. No irregularity is too small to correct.

The following sections show you how to obtain, review, and correct your credit report. I also explain how to improve your credit score.

Obtaining a credit report

The Federal Trade Commission has made it mandatory for the three major credit-reporting companies to provide you with a free credit report once every 12 months. To obtain your free credit report, submit your request online at www.annualcreditreport.com.

If you already obtained a free credit report this year and want something more recent, you can order a credit report from any or all of the following three credit-reporting agencies (prices and terms vary):

Equifax: www.equifax.com
Experian: www.experian.com
TransUnion: www.transunion.com

Inspecting your credit report

When you receive your credit report, inspect it carefully for the following red flags:

Addresses of places you’ve never lived
Aliases you’ve never used, which may indicate that someone else is using your Social Security number or that the credit-reporting agency has mixed someone else’s data into yours
Two or more Social Security numbers, flagging the possibility that information for someone with the same name has made it into your credit report
Wrong date of birth (DOB)
Credit cards you don’t have
Loans you haven’t taken out
Records of unpaid bills that you either know you paid or have good reason for not paying
Records of delinquent payments that you either know you paid on time or have a good excuse for not paying on time
Inquiries from companies with whom you’ve never done business (when you apply for a loan, the lender typically runs an inquiry on your credit report, and that shows up on the report)

Check your credit report once a year to keep track of your credit worthiness over time and to stay on top of any false information or signs of financial fraud.

An address of a place you’ve never lived or records of accounts, loans, and credit cards you never had may be a sign that somebody has stolen your identity. Yikes! Contact the credit-reporting company immediately and request that a fraud alert be placed on your credit report. For tips on protecting yourself against identity theft and recovering from it, check out Identity Theft For Dummies, by Michael J. Arata, Jr. (Wiley).

Last but certainly not least: Although you’re entitled to a free credit report, it typically doesn’t include your credit score — the measure of your “credit worthiness.” To obtain your credit score, you’ll probably need to pay a small fee.

Understanding what your credit score means

To give your credit rating an air of objectivity, credit-reporting agencies often assign you a credit score that ranges roughly between 300 (you have never paid a bill in your life) and 900 (you borrow often, always pay your bills on time, and don’t carry any huge balances on your credit cards).

Your credit score determines not only whether you qualify for a loan but also how much you’re qualified to borrow and at what interest rate. A high credit score lets you borrow more and pay less interest on it. A high score can also lower your home-insurance, auto-insurance, and life-insurance rates.

CREDIT SCORE STATS

Credit-reporting agencies rely on one or more statistical models to determine your credit score. One of the most popular models is the Fair Isaac Company (FICO) rating system. The credit company assigns numerical values to particular pieces of data in your credit history, such as the length of your credit history and the various types of interest you’re paying. They then plug these numbers into the statistical model, which spits out your credit score. It’s basically a numbers game that weighs the data on your credit report in the following manner:

35 percent of the score is based on payment history.
30 percent is based on outstanding debt or how much you currently owe.
15 percent is based on the length of your credit history or how long you’ve been borrowing.
10 percent is based on recent inquiries on your report (whenever a lending institution requests a report).
10 percent is based on the types of credit, such as mortgage or credit-card interest.

Cranking up your credit score

If you have a credit score of 700 or higher, pat yourself on the back. You’re above average and certainly qualified to borrow big bucks at the lowest available rates. Anything below about 680 sounds the warning sirens. This number is the point at which lending institutions get out their magnifying glasses and begin raising rates and denying credit. If your credit rating dips below 700, take steps to improve it, such as the following:

Dispute any erroneous items on your credit report. Disputing a claim doesn’t always result in a correction, but you can request to have a paragraph explaining your side of the story added to your report.
Apply for fewer loans and credit cards. When you apply for a loan or credit card, the lending institution typically orders an inquiry that shows up on your credit report. Evidence that you’re applying for several loans or credit cards in a short period of time can make you appear financially desperate.
Pay off your credit-card balances or at least pay off enough so the balance is 50 percent or below your available credit limit. If you have enough equity in your home, you can refinance to consolidate high-interest credit-card bills into your mortgage payment, but avoid the temptation to begin racking up more credit-card debt after refinancing.

Avoid credit-enhancement companies on the web that claim to provide seasoned credit within 90 days. Law-enforcement authorities are shutting down these sites on a regular basis. Legitimate credit counselors can help you repair your damaged credit, but it takes some work and belt-tightening. Quick fixes are typically fraudulent fixes.

Avoiding mistakes that can sabotage your loan approval

After you apply for a loan, resist the urge to make any life-changing decisions that negatively affect your current financial status. Major changes can undermine your efforts to secure a loan. When you’re applying for a loan, follow the advice of our friend and colleague, loan officer Marc Edelstein, with his Ten Commandments When Applying for a Mortgage Loan:

Thou shalt not change jobs, become self-employed, or quit your job.
Thou shalt not buy a car, truck, or van (or you may be living in it)!
Thou shalt not use charge cards excessively or let your accounts fall behind.
Thou shalt not spend money you have set aside for closing.
Thou shalt not omit debts or liabilities from your loan application.
Thou shalt not buy furniture, an entertainment center, a boat, or a big-screen TV.
Thou shalt not originate any inquiries into your credit (for example, by applying for a new credit card).
Thou shalt not make large deposits without first checking with your loan officer.
Thou shalt not change bank accounts.
Thou shalt not co-sign a loan for anyone.

To simplify the loan process, supply your lender with copies of your last three bank statements and last three federal tax returns.

If your financial situation changes between the application and the time of closing, you are legally obligated to inform the loan officer and lender of the change.

Comparing loans

When considering any type of loan, carefully examine interest rates and other factors to determine what’s best overall and which loan is most suitable for your situation. An interest-only loan may offer lower monthly payments, but it may not be the best choice. A fixed-rate loan at a slightly higher interest rate may be better.

The best way to compare loans is to determine the total cost of the loan over the life of the loan:

Start with the amount the bank charges you upfront in loan origination fees, discount points (interest you pay upfront, typically a percentage of the loan, to lower the interest rate), and other fees.
Multiply the monthly payment times the number of months you plan to pay on the loan.
Add the two amounts to determine your total payment.
Total the amount of each payment that goes toward paying the principal of the loan. (Your lender can tell you how much of each payment goes toward principal.)
Subtract the total you determined in Step 4 from the total in Step 3.

Suppose you’re considering two loans, each for $100,000. You plan on using the loan to buy and renovate a home over two years and then sell it and pay off the remaining principal on the loan. You have a choice between a 30-year, traditional fixed-rate mortgage at 6 percent or a 30-year, interest-only loan at 5 percent. Look at the 6 percent, fixed-rate mortgage first:

Loan origination fee and discount points:	$1,000.00
Plus monthly payment of $599.55 multiplied by 24 months:	$14,389.20
Equals total payment:	$15,389.20
Minus total paid toward principal:	$2,531.75
Equals total cost of loan:	$12,857.45

Here are the numbers for the 30-year, interest-only loan at 5 percent:

Loan origination fee and discount points:	$1,000.00
Plus monthly payment of $416.67 multiplied by 24 months:	$10,000.08
Equals total payment:	$11,000.08
Minus total paid toward principal:	$0.00
Equals total cost of loan:	$11,000.08

If you’ve ruled out interest-only loans because you think you’ll save money by paying down the principal, the numbers compel you to reconsider. With the traditional mortgage, you’re not only paying more than $180 more every month, but by the time you sell the house, you’ve paid $1,800 more for the privilege of borrowing the money!

As a general rule for quick flips, opt for loans with low (or no) closing costs, low (or no) discount points, and low interest rates. Avoid any loans that have prepayment penalties.

Finding lenders online and off

To secure investment capital for flipping properties, you need to know where to look. Obvious sources, such as banks, may be a little reluctant to loan money to a novice for investing in real estate, so you may need to poke around to find willing lenders and investors. The following sections show you where to start looking. Your agent can also help steer you toward lenders.

Don’t request quotes from more than a couple of lending institutions. When several lending institutions query your credit report in a short period of time, it shows up on your credit report and can lower your credit score and jeopardize your ability to qualify for a loan. Shop around first and then apply for a loan with only one or two lenders who offer the best rates and services.

Sticking close to home with local institutions

Small, local banks and credit unions often run loan specials in an attempt to lure you into doing all your banking with them. They may offer low-rate loans regardless of whether you open a checking or savings account with them. Check your local newspaper for ads, call around to four or five banks in the area to check out their loan offerings, or check with your current bank or credit union, which may offer an even better deal because you already have an account there.

If you have the choice, obtain your loan from a lender that doesn’t sell its loans. Some smaller banks and mortgage brokers sell to larger, out-of-state banks, which can foul up the handling of your escrow account (the account from which the lender pays your taxes and insurance), resulting in unpaid property taxes and insurance.

Expanding your search through the Internet

You’ve probably seen those commercials in which a couple goes online to submit a request for quotes from various lenders. The lenders descend on the house like a flock of fawning suitors and grovel to win the couple’s favor. Funny, yes, but realistic? Not quite. You still have to perform due diligence by checking the numbers, as I explain previously in this chapter.

I recommend that you stay close to home when borrowing money to finance your flip, especially when you’re first starting out. Local lenders are typically more motivated and capable of servicing your loan, and they can work with you more effectively if something goes wrong.

Borrowing for purchase and renovations with a renovation loan

Fannie Mae and the Federal Housing Authority (FHA) offer home renovation mortgage programs that enable qualified buyers to borrow an amount equal to what the property is expected to be worth after repairs and renovations. For example, if you can purchase a property for $90,000 and sell it for $120,000, you can borrow up to $120,000 to purchase the property and pay for the repairs and renovations.

To take advantage of a home renovation mortgage, you find a property to flip and then do a walk-through with your contractor (see Chapter 11) and come up with a list of repairs and renovations and their total estimated cost. You present the lender with the details, they order an appraisal, and if the appraised value of the property is greater than or equal to your total (purchase price plus cost of renovations) you get the loan, assuming you’re deemed credit worthy.

You use a portion of the loan to purchase the property, and the lender holds the rest of the money. For each repair or renovation, you obtain an estimate from a reputable contractor and then request a draw (a portion of the loan balance that the lender is holding) to be paid to the contractor. After the work is completed, a final inspection is conducted to ensure all repairs have been made. Typically, you’re given about six months to complete the repairs and renovations.

Fannie Mae offers a home renovation mortgage that’s open to real estate investors. The FHA 203K renovation loan, on the other hand, is made available only for the purchase and renovation of an owner-occupied home; that is, you must live in the property for a full 12 months before selling it. You must apply for an FHA 203K loan through an FHA-approved lender. If this option is something you want to consider, discuss it with your mortgage broker.

Securing the Funds to Fuel Your Flips

Recognizing the Importance of Being a Cash Buyer