How are renovation costs funded in a fix and flip loan?

Estimated reading time: 4 minutes.

Post Outline

1. The basic structure of a fix and flip loan
2. What % of renovation costs are typically financed in a fix and flip loan?
3. How do you obtain the renovation financing portion of a fix & flip loan?
4. An example of “floating” the first construction draw
5. Conclusion

The basic structure of a fix & flip loan

To understand how renovation costs are funded in a fix and flip loan, it is helpful to first get a solid understanding of the fundamental structure of a fix and flip loan.

A standard fix and flip loan, like those provided by a hard money or private lender, can be essentially divided into two components, 1) the portion of the loan used for the acquisition (purchase) of the property you’re going to fix and flip and 2) the portion of the loan used for the construction, or more precisely, renovation of the property.

As such, a lender may provide you a financing quote at something like, “70% of purchase price + 100% of renovation costs”.

This simply means the lender is quoting the financing of 70% of the purchase price and 100% of the renovation cost of the deal.

Our focus for the rest of this post will be the renovation costs of a fix and flip loan, the “100% of renovation costs”. There are some nuances that are important to understand as a borrower, and we’ll attempt to cover those in good detail.

What % of renovation costs are typically financed

Generally speaking, lenders will finance 100% of the renovation costs of a fix and flip project.

This is the market standard, and lenders often feel comfortable doing so because of the timing of this financing.

In contrast to the acquisition portion of a fix and flip loan, which necessarily is disbursed at the time of purchasing the property, the renovation portion of a fix and flip loan is generally financed in parts upon completion of each portion of work. The implication and, in turn, the reality here is that you will outlay the initial funds to complete a portion of the work, and then the lender will reimburse you for that work completed.

How do you obtain the renovation financing portion of a fix & flip loan?

The renovation financing portion of a fix & flip loan is done through construction draws on a reimbursement basis.

Generally speaking, you will submit a draw request to your lender, who will then schedule an inspection of your property.

An inspector will come out to visit your property, take a look at the work that’s been done, and then send a report back to the lender.

Based on this report, the lender will then disburse funds.

As you can see based on the above process, construction funds are not released when you start renovation, but rather when you’ve already completed a portion of the work, and that work has been verified by an inspector.

An example of “floating” the first construction draw

To further illustrate the above concepts, let’s take a look at a hypothetical fix and flip loan.

Let’s use the following data points:

Lender A will 80% of the purchase price and 100% of the renovation costs of your fix and flip project at a maximum of 65% LTARV.

You have found a deal with the following qualities:

Purchase price – $150,000

Renovation cost – $60,000

After-repair value – $300,000

Based on Lender A’s purchase price and renovation financing guidelines, they will lend the following amount:

120,000 of the purchase price + $60,000 renovation cost.

Is this amount less than 65% of the after-repair value?

A quick calculation, .65 * $300,000 = $195,000, tell us yes.

As mentioned, your renovation cost on this project is $60,000.

You decide to divide this up into three equal parts, or $60,000/3.

So, each construction draw, if all goes as planned, will result in a disbursement of $20,000 by the lender.

However, you will need to, in addition to putting down money for the purchase price ($30,000 of the $150,000 in our simplified example), outlay the initial $20,000 for the renovation.

This 20,000 will then be reimbursed, assuming you’ve completed that portion of work.

Then, you will need to outlay another 20,000. That amount will be reimbursed.

Then, you will need to outlay the final 20,000. That amount will be reimbursed.

As you can see, you never outlay more than 20,000 for the renovation portion of the project, but you do indeed need to “float” that amount throughout the renovation process. Once you’ve completed the renovation, then the final $20,000 is reimbursed. In this way, lenders say they finance 100% of the renovation costs, which is in fact true. By the end of the project, they will have financed 100% of the renovation costs, but the timing of the release of those funds, as detailed above, is important to keep in mind as a real estate investor.

Conclusion

In sum, fix and flip loans are generally divided into two parts, 1) the portion of the loan used for the acquisition (purchase) of the property you’re going to fix and flip and 2) the portion of the loan used for the construction, or more precisely, renovation of the property.

In contrast to the acquisition portion of a fix and flip loan, which necessarily is disbursed at the time of purchasing the property, the renovation portion of a fix and flip loan is generally financed in parts upon completion of each portion of work.

If you need financing for an upcoming fix & flip project, you can fill out our preliminary application at this link to get started.