Poor financial preparation
Financing a flip isn’t nearly as easy as securing a mortgage for your personal residence. For starters, a bank will typically lend only 80% of what they deem the home is worth. If you’re buying a distressed property, it likely isn’t worth much — plus you’ll still need to be able to come up with at least a 20% down payment plus the cost of any repairs. It’s unlikely a bank would fund those repairs in addition to the mortgage.
The other hiccup is that banks aren’t too keen on funding homes in need of big repairs — especially ones related to foundation or other structural damage. In fact, most of the time, they mandate these repairs be made prior to closing to ensure their investment is secure.
While these setbacks aren’t anything you can’t overcome, you’ll want to be sure you have good credit and enough cash on hand to make a decent down payment and fund all the repairs needed to resell later. Otherwise, you’ll be halfway through the flip with no money left to finish.
Choosing a home that needs too much work
Finding the right home to flip is the most important decision you can make in this business, so don’t make it lightly. Determining how much time and money you can invest in a flip will serve you well as you’re searching for the right property.
If you’re also working a full-time job, keep in mind that the longer it takes you to flip the home, the longer your holding costs and the higher the price you’ll need to sell it for in the long run.
By knowing how much you can handle both in terms of time and money, you’ll have a much better chance at a positive outcome. When you find a home you think is the perfect fit, be sure to inspect it thoroughly before purchasing to make sure you’ve budgeted and accounted for all repairs. Unanticipated costly repairs can really throw off your numbers.
A good rule-of-thumb used by flippers if the 70% rule. You should pay no more than 70% of the estimated value of the home after renovations — or after-repair value (ARV) — minus the cost of repairs needed. This ensures the investment is worth your time — after all, you could use this time to make money another (perhaps easier) way. Time is money.
Not knowing all your costs ahead of time
There are three things that are certain in life: death, taxes and that your project will cost more than expected. Whatever your budget, pad a little extra for contingencies — around 10% to 20% should be plenty. But, you should estimate all projects as accurately as possible so your flip is successful and you don’t end up in the red.
One major cost will be payment for contractors to do certain work on the property. It’s unlikely you’ll be doing all the renovations yourself. Get quotes from local contractors on any major projects before signing the closing paperwork. You may be surprised by some of them.
An often overlooked expense when flipping a house is the cost to hold the home while you’re renovating it. These include property taxes, home insurance, utilities, association fees (if applicable), and costs to maintain the exterior — like mowing or snow removal. While these costs will be prorated based on how long your flip takes, they can add up quickly.
There are also costs associated with selling the home once you’ve finished upgrades and repairs. Not only will you pay closing costs, you may also have to pay for the buyer’s agent commissions, even if you don’t plan on using an agent yourself.