The Basics of Rehab Loans for Real Estate Investors
By Dalton Elliott
Lima One Capital
Real estate investors have lots of different ways to profit from buying homes. But one of the most tried and true ways is by purchasing a home, fixing it up, and then selling it for a price higher than the purchase price plus the construction or rehab budget. These flips—whether they are extensive heavy rehab that add square footage, or cosmetic flips focused on paint, fixtures, and countertops—are often a starting place for new investors.
But if investors want to prevent a flip from becoming a flop, they need to know the ins and outs of rehab loans. No matter how great your fixer uppers are, the wrong financing can eat up your profits and stop your overall real estate investment strategy in its tracks.
The first thing investors need to know is the difference between renovating a home as a homeowner and as an investor. A homeowner who wants to buy a home and roll rehab costs into the mortgage loan may look for an FHA 203 k loan. This loan finances both purchase and construction costs, and it is federally backed by the Federal Housing Administration. Like most FHA mortgages, this loan will often have a low interest rate over a fixed term, and it may be found from a bank or credit union.
However, 203 k loans do not work for investors. For one thing, FHA loans require underwriting of the borrower, which may mean higher interest rates depending on credit scores. Banks also prefer to see steady income, not the irregular intermediate profits that most real estate investors have. (Investors may not receive a paycheck every week, but they will receive big payouts when they successfully sell a house flip. That type of income often makes banks skittish when underwriting a loan.)
More importantly, 203 k loans are only available for buyers who plan to live in a home for the foreseeable future. So real estate investors who plan to do 3-4 flips a year may only have one 203 k loan at a time. Also, 203 k loans are limited by FHA limits based on geography.
These limitations mean that real estate investors need to look for other sources of rehab loans. Private lenders like Lima One Capital offer programs specifically for FixNFlip investors. These rehab loans may appear to have high interest rates, but in reality, payments are much less because they are interest-only loans. During the short rehab period (typically 13 months at Lima One), the investor takes an existing home and completes home improvements, and then sells the property before the loan term is over. The proceeds from the sale of the rehabbed loan pay off the purchase plus construction price, and the investor profits. This case study from Atlanta provides an example of how the numbers can work.
These improvement loans allow the investor to finance both the purchase of the property and the construction costs. The rehab budget is placed in an escrow account, guaranteeing that the money will be available when needed.
This sounds simple, but the investor needs to investigate the draw process for construction funds. Some key questions:
How and when can they access that money?
How long will it take to receive funds from a draw?
Will they pay interest on undrawn construction funds?
At Lima One, we use a reimbursement model for construction funds, based on the percentage of construction line items that are complete. Experienced borrowers are also eligible for commitment funding, which means that they do not pay interest on construction funds until they are drawn. The entire process is managed by Lima One’s in-house construction management and servicing teams, which provides seamless service for the investor’s needs. Many other private lenders use third-party servicers that fail when it comes to customer service.
The construction draw process means that investors can pay for materials and labor out of pocket or with credit cards, but with a quick turnaround replenish their cash or pay off their cards before the bill comes due.
By finding the right rehab loan, real estate investors gain a key tool in a profitable house flip. Finding a dependable lender like Lima One Capital lets an investor profit time and again, scaling their business with simple dependable financing. Make sure you find a lender that can close loans quickly and with certainty, so that you can pounce when you find a home that is prime for a flip. By doing your research, reading advertising disclosures, and understanding terms of each lender’s programs, you can find the rehab loan you need for your next flip (or your first one).
Dalton Elliott is the Director of Inside Sales for Lima One Capital, the nation’s premier lender for real estate investors. Lima One finances borrowers who are building, improving, and stabilizing neighborhoods across the nation. For more information, visit limaone.com.