How Much Cash Do I Need to Bring to My Loan Closing?
Closing on a loan to purchase a fix-and-flip house can be a very stressful time. There are many details you will need to be ready to handle in a short time, including making sure you have the liquid funding to close your loan. Using some simple math, (yes, its simple!) you can figure out the amount of cash you will need to make sure your loan closes on time and with minimal stress.
Lets start with the basics:
First, calculate how much money you will need to purchase and renovate your fix-and-flip house. This is what we refer to as the Total Project Cost.
1) Purchase Price + Rehab Costs = Total Project Cost
For example, if you are buying the property for $65,000 and you need $35,000 for rehab, your Total Project Cost will be $100,000.
Next, well use a formula to find 65% of the After Repaired Value of the property (ARV). 65% of ARV is the highest amount you can borrow within our terms, or your Maximum Loan Amount. If you are unsure about the ARV, remember that your appraiser will provide one based on the current local market and your proposed renovations. Use the ARV of your project to calculate your Maximum Loan Amount using the following formula:
2) After Repair Value X .65 = Maximum Loan Amount
Following our example from above, RFG would be able to lend you up to 100% of your Total Project Cost ($100,000) if the ARV was at least $154,000. This is because $100,000 is 65% of $154,000.
As long as your Maximum Loan Amount is GREATER THAN your Total Project Cost you will not need to bring extra cash to closing. You can calculate the amount of cash you will need using the formula below:
3) Total Project Cost – Maximum Loan Amount = Cash Needed at Closing
[not including closing costs]
In the above scenario, if the ARV is LESS THAN $154,000, then RFG would not be able to lend you 100% of your Total Project Cost. Lets say that for this project your ARV is $145,000. Your Maximum Loan Amount would be $94,250 (which is 65% of $145,000). As the Total Project Cost is $100,000, the difference between Total Project Cost and Maximum Loan Amount is $5,750 ($100,000 – $94,250 = $5,750). You would need to bring this $5,750 in cash to closing to be applied towards the purchase of the property.
Since ARV is calculated using the planned renovations you have already submitted, you wont be able to reduce your Total Project Costs without also lowering the ARV. This will also lower the Maximum Loan Amount. If your project requires more than 65% of the ARV, you will be responsible for bringing the difference to closing.
A final limit on the Maximum Loan Amount is that RFG will not fund more than the appraised as is value of the property towards the purchase price.
Dont forget about the other costs not covered by your mortgage . . .
In addition to the monetary difference from above, you may need to bring additional cash to cover closing costs, which include title and insurance related costs and lending fees. These costs must be paid with your own funds regardless of your loan amount or ARV value.
Remember, you will also need to use your own funds to make the monthly payments due on the loan as you are flipping the property.
Why we loan up to 65% of ARV . . .
Its important to understand that if the Total Project Cost is significantly more than 65% of the ARV, it becomes more likely that the project will be unprofitable. A flip with a small profit margin will require the same amount of work and risk as one with a much larger margin therefore you are better off looking for a better flip than accepting a smaller profit.
A common mistake that borrowers make is to underestimate the profit margin needed to make the project worth their time and effort. For example, $124,000 for purchase and rehab with a $154,000 ARV will not work out, though it looks on the surface to be a $30,000 profit. Carrying costs, realtor fees, transfer fees, and other expenses will consume the supposed profit and dwindle it down to a figure that isn’t worth the time, effort, and money you will invest in the project. RFG offers 65% of the ARV because that is where we know our borrower will be successful and earn a generous profit if the project is managed well.
Being thorough in your diligence is essentially the message of most our articles, but even more so in this one. As the borrower on a project where you expect to make a healthy profit, no stone can go unturned. You need to have a plan. When that plan goes awry, your plan will have a backup plan. There is always an unforeseen problem, but you need to be ready and have a lender who is willing to put in the same amount of time and effort as you.