When it comes to financing a flip, two things come to mind. The first, is that probably 50% of people who want to get into flipping houses don’t move forward because they can’t obtain financing. The second, and most important, is that the lack of understanding around financing and rates, which is a major contributing factor to flippers who don’t make a profit or break even.
What you have to keep in mind, is that flips require much more equity/down payment than a primary residence. In Ontario, an investment property, or secondary property, requires a 20% down payment. Along with that, your income has to be able to facilitate carrying the additional debt load, which makes financing a flip that much more difficult. Unfortunately, once most people have their mind set on a flip, they throw basic financing fundamentals out the door and ultimately end up going anywhere they can to get approved, even if the rates are above 10%!
With that in mind, I’m going to walk you through how I obtained financing for my flip, as well as how I selected the lender. I will preface this by letting you know that I have a fair bit more equity than most people, and that alone makes obtaining financing and having more options much easier. However, even with that edge, there are still potential pitfalls I had to overcome to ensure I wasn’t going to get myself into a situation where I would bleed money.
Working with a Broker who has personal relationships with senior mortgage underwriters.
When it comes to any form of business, relationships matter. There are a lot of mortgage brokers and internal mortgage specialists at major banks, but very few people who have direct relationships with those who can pull strings. I’m not talking anything fraudulent, simply someone who has the ability to say, “trust me, they’re good for it”, to a lender and have them overlook the pre-set lending formulas their system spits out.
In my case, I decided to have my accountant broker my financing. He has a lot of high net worth clients who have large projects financed at great rates. The biggest factor in my decision to go through my accountant, was that he has never ONCE had a client default on a mortgage that he’s set up. That type of track record, and the credibility that goes along with it, allows his connections to trust that his clients are the type of people a bank would want to work with.
In addition, I have personally seen my accountant get deals financed that were initially rejected. This is due to his understanding of numbers, in far more detail than a regular mortgage broker. Also, his title provides him with more influence when talking to lenders, and pitching the deal.
Lastly, it is extremely difficult for a self-employed individual to get financing. While I own my home outright, I needed a mortgage above $1,000,000, and I didn’t want the hassle of extensive paperwork, the back and forth or being overly scrutinized. Since my accountant has access to all of my records, both personal and corporate, it was much easier for him to put together a deal based upon my net worth, as opposed to a formal mortgage qualification.
The Documents Required for Financing a Flip.
It wasn’t all just a walk in the park however. Obtaining my financing still required a bit of work. I had to provide my personal, business and corporate documents for the previous three years, verify that I had the funds for a 20% down payment on the property and show that I had the funds to pay the land transfer taxes.
For most people who are obtaining financing for a flip, you will likely need your 20% down, as well as qualify based upon the bank’s Gross Debt Service ratio OR Total Debt Service ratio. This can be a little difficult depending on how much debt you have on your principal residence, in addition to any additional debts you may carry. Before you even consider a flip, you will want to make sure that:
- The mortgage on your principal residence is 20% or less of the market value. I am relatively risk adverse, and while I love a good opportunity, I won’t ever jump on something if I am not 100% confident that financing it will be easy and won’t put my family at risk.
- You have ZERO credit card debt and have only one credit card. The less credit you have access to, the better for getting financing. Along with this, you don’t want to play around with debt. While you can possibly avoid it for a few months, you can never escape it. I have seen this with many people who thought they had things under control, only to have everything collapse over a minor shortfall in money.
- Develop a mindset for success with the understanding that you can survive if you lose whatever is invested. This may seem extreme to some, but this is how I go about investing. As far as I am concerned, if I am not willing to, or cannot afford to lose it, I am not risking it. This has naturally led me to more stable investments, and engaging in larger ones only when the risk is calculated extremely well in my favor.
- You would take the chance; even if you were to lose 10% of what you invest. This is an interesting one, but probably the most valuable advice I can give. You need to be completely objective when buying a flip. The market is the market. And while you might be able to upsell all of the amazing things you put into the house, and feel it’s “worth it”, you are not buying the house. I’ve seen a lot of people bleed money because they hold on to a fantasy idea of the profit they believe they should receive. If you try to push beyond what the market can bear, you will end up losing money and you need to know that this business really doesn’t care about your personal feelings.
- The interest rate on the mortgage is within your investment analysis. The cost of borrowing is going to be your biggest expense aside from the actual renovations. When I invest, I want to paint the most realistic picture of how “good” of an investment I am making, and unless I know what my cost of borrowing would be, and how it impacts my return, I wouldn’t buy a flip.
Choosing the Lender for financing a flip
In a perfect world, you will have several options for financing a flip. In the real world, you probably won’t have more than 3-4. On the surface, it will look as though there isn’t much difference from one lender to the next, but I have learned to use specific criteria that I know will result in the most favorable outcome. In order of importance, my selection factor is as follows:
- Is one lender providing a rate that is at least 35 basis points better than the next? In plain English, that is a mortgage rate that is 0.35% less than the next competitor. While there are many other determining factors that can have an impact on you financially, none will typically exceed the cost savings in the rate.
- Can you get a 30-year amortization? When you have a mortgage on an investment property, the interest is deductible against your gains. Having a longer amortization period means your monthly payments will be lower because they are spread out over an additional 5 years. Given the amount of time you will own the house, the additional interest payments would be nominal, and it reduces the amount of capital outlay during the course of the project. Used properly, there are a lot of benefits to having a 30-year mortgage; including on your principal residence.
- What documents does the lender require? As I mentioned earlier, I am self-employed and I don’t want the stress of having to pull up my T4 from 2015 and jump through a bunch of hoops. The ease of obtaining financing is a criteria I’ve found to be quite appealing in terms of the process of financing.
- Is there a “set-up” fee? Hidden fees are a killer and this is one better avoided. While the cost is never excessive, I have a fundamental disagreement with having to pay a bank in order to….pay a bank.
- Can you get a six-month open mortgage? You don’t want to have any pre-payment penalties, and you don’t want to commit to a mortgage longer than is needed. Some banks just don’t want to finance flips or have short term mortgages, which is fine, but to me, I prefer to not have any strings attached.
- Is there flexibility? Some lenders have features like the ability to skip a payment. While I wouldn’t likely use this, if a lender has some built in benefits, I would favor them.
- What insurance coverage do they require? Probably the last thing people look at when financing a flip, but definitely one of the more important items, because you NEED insurance. Even though you can get financing, lenders also want to make sure their investment is secured. I know a lot of people who will fail to mention that they are flipping the house and I think it is one of the worst things you can do. You want your house and your equity protected and there are many negative consequences in lying to an insurance company on your application. While I can go into further detail, I will keep it succinct and give you the meat and potatoes only. If something happens, and you try to make a claim and the insurer finds out you lied on your application, you probably won’t get covered. You want to make sure you are covered if someone steps on a nail, let alone if the house falls down. The insurance premiums for a flip are MUCH higher than a regular residence but what you want to make sure of is that you are fully covered in the event of an issue, but also that the lender’s requirements on the type of coverage is favorable for you. This is another one of those “I can talk about this forever” things, but essentially, the biggest thing impacting the rates will be how an insurance company assesses the replacement value/cost. You want the number they use to be at or above the value of the cost of the home, because if they believe the home is worth much less, then you will have an issue getting the policy. Unfortunately, the value of land is not the biggest consideration for insurers, so when you are buying a flip where land value plays a big factor in price, as it was in my case, you want to make sure the bank financing your home has more relaxed criteria on the insurance policy you need in order to obtain your mortgage.
After it was all said and done, I was able to get myself a mortgage with Scotia Bank for 3.19%. They not only provided the best rate, but they also met all of the criteria which was important to me for financing my flip. Overall, getting my financing was a fairly easy process and the rate I was given came in below the interest rate I used in my investment analysis. So if everything goes according to plan, I will be able to profit a little more than I initially expected!
In closing, I hope this post provides you with some insight into how to obtain the best financing for your flip venture. I’ll keep you posted as my project moves forward, and as always, feel free to ask me any questions as you move forward in your own flip journey.