5 Tips on Legally Funding the Repairs on a Fix and Flip
by Craig Chambers, Attorney At Law
The Littleton Lawyer
September 2, 2018, Vol 1.82
As a lawyer specializing in real estate and property law in Littleton, Englewood, Centennial Ken Caryl, Highlands Ranch, Lakewood, and the Denver Metro area, here are few tips on how to legally fund the repairs for a fix and flip property.
First, if you find a true fix and flip, there are a lot of financial issues for the repairs to consider. Please please have the home inspected. Also, please check the zoning department and make sure that the property is zoned for purpose for which you intend use it. Check with the Homeowner’s Association, if there is one, to see what kinds of approvals you need prior to doing the work on the property.
Repairs such as roofs, radon, sewer repairs, electrical and plumbing repairs are health and safety issues you should usually insist on the Seller repairing at his expense. If the deal dies, now that the Sellers knows about them, he will have to disclose the problems to the next buyer. A typical buyer will insist on the home being a safe place to live.
Don’t count on the lender catching any of these problems. The lender does not usually inspect the home; the lender orders an appraisal which is not an inspection. The appraiser can make conditions such as roof repairs, but his purpose is to ascertain he value of the home as security for the loans.
As for repairs on the home, you need to assess your skill set and find reliable contractors to do what you can’t and don’t have time to do! Also, the Seller can’t give money back to the buyer. It affects the lenders loan-to-value ratio.
Neither can your real estate broker. The lender is entitled to know what the true terms of the deal are and make its loan accordingly. Side deals could be construed as loan fraud and the lender could call the loan due as well.
Here are a five ways to get the money to pay for the repairs.
- Seller paying your closing costs. This is by far the easiest way to get money for the repairs. Take a closing cost credit lieu of the repairs. If the repair costs are greater than the lender’s actual closing costs, the extra funds can be applied to points to reduce the interest rate of the loan. The credit can include title costs and HOA costs as well so long as NONE of the money goes directly back to you as the buyer. There’s a limit on the amount that the Seller can pay, though. Usually a percentage of the purchase price. You need to find out what that limit is from your lender.
- Reduce the price. That simply gives you more equity in the home but no cash for the repairs. If you are planning on drastically reducing the price, paying for the fix-up with a credit card or private loans, and then refinancing at the higher price after the fix-up to pay off the debt, the lender will make you wait six months before you can do the cash-out refinance.
- FHA 203K loans or similar loans. These are loans where the lender funds the fix-up as part of the deal. They can be difficult because the lender will inspect everything as the work is done. Can’t say I’ve had much success with these, most of us don’t want the lender involved, but those loans are out there.
- A fourth way is for the Seller to do the work before closing but then the warranty and/or relationship with the contractor is between the Seller and the contractor, not with you. Depending on the type of work, it is usually better if you choose and control the contractor. You could insist on the Seller doing the work with your contractor so you have some say in who does the work. Beware if the seller wants to do the work himself, he might do a crappy job.
You should get several written bids, though because the costs of labor varies enormously between contractors.
- As a fifth alternative, you could get bids from the contractors and the money is paid directly to the contractor and/or escrowed at closing. Some lenders and title companies won’t allow the escrow so that means the check gets paid directly to the contractor from the title co. Check with the lender and title company to see if that’s possible. Anyone can be the contractor (so long as its not the buyer). The check could be paid to a third party, doesn’t matter who.
What a Seller will do depend on the motivation of the seller and how strong the market it. It almost always takes longer than you think and costs more than you estimate because you will find additional problems as you go along.
A project like this can be financially rewarding.