After years of decline, the real estate trend of investing in and flipping properties is back.
In fact, more than 6% of home sales in 2016 were flips. That's the highest number in a decade.
There's a lot that goes into a successful flip-and-sell investment, including using the right type of loan to finance the project. Rehab loans are specifically designed to offer investor rehab funds for people who want to purchase and renovate a property to sell. These loans can also be used for long-term investors looking to renovate rental properties.
Rehab loans can be tricky to navigate, regardless of how you plan to use the funds. We're here to help you better understand these unique loans, so you can make smart investments that benefit you in the long run.
Read on for 5 things you should know about investor rehab loans in Kansas City.
1. There Are Two Types of Rehab Loans
Like conventional loans, rehab loans include more than one unique type of loan. The two main types are hard money rehab loans and permanent rehab mortgages.
Hard money rehab loans are more popular for buy-and-flip investors. We'll still review both types, so you can get a full picture of the different options.
Hard Money Rehab Loans
These loans are used to purchase, renovate, and sell property quickly. You can pre-qualify for a hard money rehab loan, which is the most common route, or you can apply once you find a property you want to flip.
Once you are under contract for the property, you inform your lender of the contract price, as well as the estimated renovation costs and the after-repair value (ARV). For now, you can think of the ARV of the estimated price you can sell the property for once renovations are complete.
Your lender will appraise the property and determine whether the ARV you provide is accurate. Once they agree to fund your loan, you can close on the home and get to work rehabbing it.
Permanent Rehab Mortgage Loans
Long-term investors who want to renovate property that they plan to rent out can use a permanent rehab mortgage loan. Homestyle Renovation (HSR) loans and FHA 203(k) loans are the two primary options for long-term rehab loans.
Homestyle mortgage loans are the more common of the two options, but there are some drawbacks. An investor can only purchase one investment property at a time, meaning you can only renovate one property at a time if you use a homestyle long-term loan.
Hard money loans are more beneficial for investors who are looking to buy and flip homes quickly. For our purposes, we're going to focus mainly on these types of rehab loans.
2. Rehab Loans Come with Higher Rates and Stricter Terms
Rehab loans aren't like other home improvement loans. Lenders are taking more of a risk when putting up the funds for rehab loan than when they finance a conventional mortgage or renovation loan. They manage this higher risk by placing higher interest rates on the funds and offering shorter terms.
The first thing you'll notice about the terms for your rehab loan is the interest rate, which will typically fall between 7.5 and 12 percent but can even be as high as 18 percent. This covers the greater risk the lender is taking by offering the funds. Because of the higher rates, you'll be making interest-only payments throughout most of the term and will repay the principal at the end of the loan.
There will between 1 and 10 points on your rehab loan, which are part of your closing costs and equal 1 to 10 percent of the total loan amount. These points can be prepaid interest to guarantee the lender receives a return regardless of repayment. More commonly, though, the points are considered fees used for underwriting and origination.
The loan term will also be much shorter than a conventional loan. You'll likely be required to repay your rehab loan within 12 to 36 months. This should be enough time for you to complete your renovations and sell the property.
You may be required to purchase specific insurance for your property as well. The insurance on vacant property or one currently undergoing renovations can be up to 20 percent higher than a typical policy.
3. Rehab Loan Qualifications Are Stricter
Not only are the interest rates higher and terms shorter, but the qualifications for receiving a rehab loan are stricter as well. This all ties back to the risk that comes with financing this type of investment.
Perhaps the most unique qualification you may find is that your lender may require you have some real estate experience. They want to be sure that you know what you're doing and can make a return on your investment. Your lender may require that you've already completed one or two similar projects, have a construction background, or that you work with a licensed contractor.
The down payment required for your loan will be based on the purchase price or the ARV. It can be 15% to 35% of the home's current value or 25% of the ARV.
4. The ARV Is an Essential Part of a Rehab Loan
We touched on the ARV several times already, but this aspect of rehab loans deserves additional attention.
Because rehab loans combine the property's initial purchase and rehab budget into a single loan, the ARV needs to factor into the overall loan amount. Again, your lender wants to feel confident that you'll be able to repay your loan. They need to be sure that you're going to be able to sell your investment property for a proper amount to allow repayment.
The ARV ratio that hard money lenders use to set the maximum loan amount is just a percentage of the property's expected fair market value (FMV) after renovations are complete. If you're investing in a property in good condition, you may receive a loan for up to 90% of the initial purchase price, but this is rare.
Lenders typically will only finance rehab loans up to 65% of the ARV or 85% of the purchase price, since most of these properties aren't in the best condition.
You can estimate the ARV by using calculators available online, or by working with an experienced lender.
5. You Should Come Prepared When Applying for a Rehab Loan
As you've learned, there are many moving parts when it comes to obtaining a rehab loan to finance the purchase of an investment property.
When you find the right property, you're going to want to move quickly so that you don't lose it. Be prepared with all the information and documentation you need to apply for your rehab loan in Kansas City. Pre-applying is also a great option for ensuring you're ready when the ideal property becomes available.
Whether you're pre-applying or not, you'll need to share your personal bank statements, so have those ready. You may also want to prepare the proof of any past projects you've completed and any rehab experience you have. This proof can be prior purchase agreements, renovation invoices, and a receipt of sale or refinance for a past project.
If you don't have any prior rehab experience, there are other things you can do to help make the case for your loan approval. One option is to partner with a licensed contractor and provide their information, as well as information on the scope of the work that is planned, the bid, and the timeline for completion. This information can also be used to help calculate the ARV for the property.
Once your loan has been approved and you can begin renovations, start planning your exit strategy. Remember, these loan terms are short. Make sure your renovation plans are solid and that you've done the research necessary to show you have a good chance of being able to flip and sell the property.
If you are unable to sell the property, you may need to refinance the home. Keep this in mind as your loan term comes nearer to completion. Exit strategies can take time, and you want to avoid incurring additional costs with your lender while you wait for a sale to close or new financing to be approved.
Partner with the Right Lender for Your Rehab Loan in Kansas City
Want to ensure that your loan process is as smooth as possible? Work with a reputable and experienced lender. By partnering with a lender with specific experience in rehab loans, you can feel comfortable that you're getting the best deal and that everything is being handled properly.
Contact us today to learn more about our lending and mortgage options available for Kansas City homebuyers. In addition to rehab loans for investors, we offer conventional home loans and refinancing.
We want to be sure that you are as informed as possible throughout your loan experience. Browse our site to learn more about how to avoid first-time homebuyer mistakes, tips for paying off your mortgage, and more.