The 3 Costs to Flipping Houses & How to Pay for Them with Little Cash! (Part 1: Purchase the House)
Updated: Jun 3, 2022
How can I flip a house with very little cash of my own? How much money does it take to flip a house? What are the renovation costs? What's the most efficient way to finance a flip? Where can I find money to flip a house? These were all questions that raced through our minds as we approached the house flipping world and I will answer all of those questions and more in this 3-part post!
Tyson and I spent 6 months talking to experienced flippers, real estate agents, and lots of googling to learn everything we needed to know before flipping our first house. In the process, we learned how to finance a flip with very little money of our own. We spent those 6 months also getting our finances in order so we could do exactly that!
As you already know, the day we finally had the green light to purchase a flip was the day I learned the company I worked for was closing and I would be let go. My job gave us the wiggle room we needed to pursue a flip comfortably, so we put a pause on those plans and I am getting my real estate license in the meantime (WOOHOO!). But I figured just because we put a pause on our flipping endeavors doesn't mean you have! So, let me share with you everything we learned and all the ways you could financially prepare for your first flip too!
Here we go!
There are 3 main costs that need to be covered in flipping a house:
Purchasing the house
Each of these 3 costs look VERY different in the flipping world than in the real world. You may know how to purchase and renovate your current home, but purchasing and renovating a flip is a whole new world.
REMEMBER: Your goal is to purchase, renovate, and sell the house as quickly as possible; time is money! The quicker you can flip a house, the quicker you can collect your profits and go flip another house. It can sometimes cost more to move at this quicker pace, but your mindset in flipping houses should be: "Money now is better than money later."
Does this sound like the opposite of everything you've ever been told? That's because it is! Ha! When you are funding a flip with very little cash of your own, then that means it's going to cost you money to make money. The longer you take, the more it's going to cost you and the less you will make in the end.
Let me break down each of these 3 costs over the span of 3 posts and explain the specific financial hurdles you'll come across and how to financially overcome them.
#1: Purchasing a House to Flip
If you already own a home, purchasing a second home looks very different than how you purchased your first. In order to purchase a second property through a typical bank loan, you need a 20% downpayment. This means if the house costs $300,000, you need $60,000 CASH to put towards a downpayment. Sometimes your bank can work with you if you have incredible credit and you can prove you can afford the property. But, for argument's sake let's agree that you need a lot of cash as a downpayment. Also, regardless of your purchasing your second home or your first, if you put down less than 20%, you're monthly mortgage payments will be higher because you will additionally be required to have mortgage insurance (literally insurance on your mortgage because you're a "riskier" buyer).
Another hurdle: Cash-only properties. When flipping houses your goal is to purchase the house for as CHEAP as possible. What's the best way to do that? Purchase the house before it even hits the market and gets attention from other buyers. This is called "off-market" houses. However, all off-market houses require cash-only purchasing. No mortgage, no financing, nothing. If the house is 400k, you need 400k in cash to purchase it. That's even more money than the 60k we were just talking about!
Before I address how to get the funds to overcome these financial hurdles, let me explain the best ways you can find a house to flip:
Purchase a home from a wholesaler (Off-Market & Cash-Only) - These are crazy! Haha! A wholesaler is a business that sells houses that have never actually hit the market to investors (like yourself). How it works is you connect with a wholesaler, let them know the kind of property you're looking for (size, price, condition) and they email you (along with their whole contact list of investors) properties as they receive them. If you see a property you like, you call the wholesaler ASAP and you offer to buy the property! You meet them at the house and give them 10k in a cashier's check or you wire the funds directly to them without even meeting them at the property. If you are the first buyer to produce a cashier's check/wire the funds, the house is yours! No inspection, no negotiation, nothing. Sometimes properties are sold within 15 minutes of them being emailed out! After the 10k cashier's check is produced, you have a short period of time (a week or so) to produce the rest of the funds in cash.
Pros: You get the house for a deal, you get the keys the same day, and there's no driving up the price with multiple offers.
Cons: Because the price isn't negotiable, wholesalers can set the price higher to compensate for this. Especially considering the current housing market where inventory is low and demand is high, they know they can set the price higher and still attract buyers. Also, purchasing the property sight-unseen with no inspection can be so scary. It could need a new roof or structural issues. If you've been flipping for a while, wholesale properties probably don't scare you as much as they would a first-time flipper.
Purchase an auction home (Off-Market & Cash-Only) - When a house gets foreclosed on, it goes to auction with an incredibly low starting bid. The auctions typically take place on the courthouse steps - so strange and crazy right? Ha! We've been to a few just to watch and get a feel for the process and it's unreal. How it works is you look up the list of homes being auctioned on X date (download the auction.com app - that's a great place to start), you research the homes and pick which one(s) that seem like a smart investment (it's a good idea to have a back up in case your #1 choice becomes unavailable or the bids get too high), decide on a max amount you're willing to pay for the property and come to the courthouse steps with a 10k cashiers check to be approved to participate in the bidding. You can expect bids to raise the price well above the starting bid, but every bidder's goal is to purchase the property for as little as possible so you should walk away with a deal. Just know your max bid and stick to it!
Pros: You get the house for a deal (as long as you stick to your max bid and did your research), you essentially get the keys the same day, and you have time to do your homework and research on the property prior to the auction.
Cons: Evictions can be a nightmare. The best thing you can do is a "cash for keys" - offer the previous homeowners a couple thousand dollars to move out by X date. They will typically accept the money and honor the cash for keys contract because it's a good chunk of free money if they just cooperate. However, if they don't accept it or cooperate, it can be a long legal battle to evict them (time is money!). Another con is that although you should be able to do a drive-by and visually "inspect" the house before the auction, you're still purchasing the home sight-unseen with no inspection. Lastly, if there are any liens on the home, you are taking on those liens when you purchase the property. An example would be if the homeowners weren't paying their taxes the IRS can put a lien on their home for the amount that they owe in taxes. If you purchase a house with a tax lien, you now owe that money to the IRS. Insane, right?! Fortunately, ALL property liens are documented as public records so ALWAYS check for liens on an auction home before purchasing them at auction and you should be fine!
Purchase the home through a real estate agent (On-Market) - This is your typical, most comfortable, and safest way to EVER buy a house.
Pros: You get an inspection and can walk the property prior to purchasing. You really don't take on any unknown risk regarding the property itself or the current owners/tenants. You have more time to do your research and be strategic and deliberate with the homes you pick to purchase; it's a more methodical and safe process. The best part is you have a real estate agent right by your side as a second (professional) opinion; they will help you run the numbers to make sure it's a good investment property, pick a good area to flip in, and find the perfect type of house for you. Having that extra help on your first flip would be huge! Sometimes real estate agents, because of their many connections, can find you a home before it hits the market too! That's the ideal situation!
Cons: Closing can take longer (time is money), and with the way the market is now you'll want a cash offer and it could likely be well above asking. You may be purchasing the house for more than you would if it was purchased off-market. Also, you want to purchase ugly/fixable houses; usually, sellers will spend some time getting their home ready to sell (make repairs, paint, maybe update the floors), whereas off-market properties are left as is and thus should (in theory) cost less.
I will include that there are other ways you can purchase houses to flip that are more invasive and direct, however, still super effective; like mailing flyers to homes you've researched and would like to buy or literally knocking on doors and telling people you are an investor and you would like to purchase their home. These options are more reasonable when you've really got your feet wet in the industry.
How to fund the purchase of a flipper house
Now that you know the best ways to purchase a house to flip, we learned that cash offers are almost always necessary, and if you're purchasing an off-market house you'll need 10k cash. Here's the next question we need to tackle, "How am I going to get my hands on some money? And a lot of it!"
Finding an investor will be HUGE, if not foundational, to flipping a house with little cash of your own. Most house flippers will use what is called a hard money loan to purchase a secondary home, and after looking into MANY financing options this is what we found to be best. Remember that hurdle of needing 20% down on a second property? Boom! Problem solved if you just pay for the whole thing in cash from a lender!
Hard Money Loan - People, usually who have experience in real estate, with lots of money want to invest their money to make more money. One way they can invest their money with a quick return is to invest it in YOU - house flippers! They will give you cash to purchase a house and/or renovate at a higher interest rate (usually between 10-12%). Interest is usually paid monthly or at the close of the loan (more ideal, but less common).
Why a hard money lender? There's no extensive pre-approval process. I could literally purchase a home from a wholesaler today with my 10k cashier's check, and go find a hard money lender tomorrow and we could have funds for the home wired within a week. Remember: Time is money.
How do you find a hard money lender? Hard money lenders are usually a lending company or a private investor (literally some guy/gal with a lot of money). Here are ways to find one:
Talk to a real estate agent, odds are they know someone - they always do! That's how we found ours!
Search Facebook for local "Fix and Flips" groups. I joined at least 5 groups and investors are always posting to put their feelers out there for an opportunity to invest. Even better, message someone on the page who clearly flips houses and ask them who their hard money lender (or investor) is and go from there. Referrals are the best!
Google search "Real Estate Investors near me." Here's an example of a lender in my area to give you an idea of what you're looking for: Orchard Funding.
It's good to have a pool of hard money lenders that you've connected with so when you're ready to pull the trigger on purchasing a home, you can call each one of them and negotiate the lowest possible interest rate.
How does hard money lending work? The lender gives you cash upfront to fund your flip. This money can be used to purchase the home in cash and/or renovate the home. The loan will have a 10-12% interest rate for a 6 to 12-month term. You will typically pay monthly in interest-only payments or less commonly (but more ideal) at the end after you sell the house. Paying back the loan and interest at the end is more ideal because you can use the profits from the sale of the flip to pay back the interest rather than having to scrounge up the cash for your interest-only payments due monthly during the flip. Unfortunately, if you are new to flipping you will probably be on a monthly interest plan since you're a more "risky" investment. That just means you need to make sure you have enough savings (cash!) for at LEAST 6 months of interest payments ready on hand BEFORE you purchase a flip.
What will they pay for and what will I pay for? You can work this out with your investor. However, it's incredibly rare that they will fund the entire purchase of the home AND the renovations without expecting you to have any skin in the game. Couple of ways this can pan out:
They produce 90% of the funds and you produce 10%. Example: 300k house + 60k renovations = 36k cash that you need to produce (not including interest payments).
They cover the purchase price of the house and you cover the renovations (and don't forget your interest payments).
You work out a custom deal based on the cash you have/are available to you. This is a little rare as the lenders usually make the rules when you are a new flipper, but who knows! (Also, don't forget to include interest payments! Haha.)
I will dive headfirst into what these interest payments will look like (math and all) in the next post - Part 2: Carrying Costs so you know EXACTLY how much cash you need to fund your first flip! Let's go!