The fix-and-flip investment strategy has been a leading approach in real estate for years and is becoming increasingly popular in Maryland. Known for its potential to generate substantial profits quickly, this method remains effective whether you flip the property or choose to hold onto it.

This strategy involves purchasing properties at discounted prices that require significant repairs or renovations. Investors may acquire these properties through various channels—off-market deals with motivated sellers, wholesalers, or listings found online or via real estate agents.

After securing a property at a reduced price, investors typically invest in necessary repairs and either sell the property for a significant profit or rent it out. An effective strategy used by investors in Maryland is to develop a network of buyers, including those seeking ready-to-rent homes or individuals looking for new residences.

Types of Fix-and-Flip Loans

Fix-and-flip loans come with several names, including:

• Fix and Hold Loans
• Hard Money Loans
• Private Money Loans
• Rehab Loans

Bridge loans are occasionally considered for fix-and-flip projects, though they generally have different terms and structures.

Advantages of Fix-and-Flip/Rehab Loans

In Maryland, astute investors understand that real estate is often a liability, making it advantageous to use external financing for such liabilities while preserving personal funds for long-term assets.

Unlike DSCR Loans, which often include prepayment penalties, rehab loans usually do not, allowing for early repayment without additional costs. These loans are typically interest-only, resulting in lower payments as there is no principal repayment involved.

The high leverage provided by rehab loans is another key advantage, reducing the amount of personal capital needed to get started. While some financing options might cover up to 100% of the purchase price and rehab costs, these are rare and challenging to secure. More frequently, financing will cover 80-90% of the purchase price and the full cost of rehab, with these figures potentially adjusted for quicker closings.

Essential Terminology

Understanding these key terms is crucial when evaluating rehab loan options:

• LTV (Loan To Value): The percentage of the purchase price financed.
• LTC (Loan To Cost): The total cost of purchase and rehab.
• ARV (After Repair Value): The estimated value of the property once repairs are completed.
• SOW (Scope Of Work): An itemized list of repairs and their costs.
• DRAW: Funds allocated from the loan to cover repair expenses.
• RESERVES: Proof of available funds, typically a percentage of the total loan amount.
• LEVERAGE: The percentage of purchase and rehab costs covered by the financing (high leverage means a larger portion is financed).

Loan Terms and Conditions

The specifics of rehab loan terms vary based on several factors, including the borrower’s options, qualifications, and property details. ARV is often a limiting factor in the amount that can be borrowed. Ideally, the ARV should be significantly higher than the total cost (LTC) to maximize financing. Generally, 75% ARV is the maximum, so even with full financing, the property’s end value needs to be 25% higher than the total costs.

Qualifying for a Fix-and-Flip Loan

In Maryland, several factors determine whether a borrower qualifies for rehab financing:

• FICO Scores: Typically, a minimum FICO score of 640 is required. While some options exist for non-FICO lending based on property and borrower experience, these are rare. Higher FICO scores (660-700) often result in better terms, with scores above 700 offering the most favorable conditions.
• Experience: A borrower’s experience significantly impacts loan terms. More experience generally leads to better rates and terms. Borrowers with experience on 3-5 similar projects in the past 2-3 years usually secure better conditions. Experience must be publicly documented, such as through HUD records, and rental properties count only if they were rehabbed.
• Location: Rural properties may face lower leverage or limited financing options. Declining markets, characterized by decreasing population or property values, can affect available financing. Comps (comparables) are also important; a property with a high ARV compared to local market values may be considered overpriced.
• Proof of Funds: Borrowers need to demonstrate they have sufficient funds for the down payment and reserves, usually covering 3-6 months of financing costs and initial rehab expenses.
• Scope of Work: An SOW from a licensed contractor is required, detailing each repair and cost. Typically, 10% is added to the total SOW amount to cover unexpected costs.
• Light vs. Heavy Rehab: Rehabs are categorized as light or heavy. Light rehabs involve minor updates without major structural changes, while heavy rehabs include significant structural work or stripping the home to its foundation. Heavy rehabs often require stricter lending terms and more experience.

How Rehab Loans Operate

In Maryland, if an investor already owns a property, a rehab loan (often called a bridge loan in this scenario) can be used, and the initial purchase financing may not be needed. However, most investors buy the property and then proceed with rehab.

The first part of the loan covers the property purchase. For example, with a 90% LTV, the buyer provides a 10% down payment, with the remaining amount financed.

Once the purchase is complete and the rehab begins, the next phase of financing comes into play. Typically, the borrower covers initial rehab expenses out-of-pocket but is reimbursed after providing proof of work, such as photos and receipts. Each rehab phase is paid for by the borrower, who then requests a draw for reimbursement.

The rehab portion of the financing is rarely provided upfront; instead, it is reimbursed as the work progresses. Borrowers need access to some funds or credit to initiate each phase of rehab. Interest is paid on the purchase financing throughout the loan term, and depending on the financing option, interest on the rehab portion may be charged on the total amount or just the borrowed portion.

Exit Strategies

The investor’s exit strategy is crucial when securing financing. If the property is to be sold, it’s essential to determine the likely sale price and timeframe. For rental properties, understanding the expected rental income is important. Investors planning to hold the property might consider refinancing into a long-term loan, such as a DSCR loan, for lower rates and extended terms.

Expert Assistance with Your Rehab Loan in Maryland

With the numerous options and variables involved in rehab loans, seeking professional guidance is advisable. We can help you navigate the process and find financing solutions that align with your investment goals and circumstances.