House Flipping Terminology: House Flipping 101
When you decide to start flipping houses, there are a lot of words and terms that you will need to learn. As you look at different loan offers, the vocabulary can be very confusing. We’ve compiled a list of the most common words in the industry.
Getting familiar with these concepts is the first step in your fix and flip career. Once you master them, start looking for property and plan your first renovation.
2-4 plex
A designation for different types of residences. 2-4 stands for duplex (2), triplex (3), and fourplex (4). Du, tri, and four all describe how many residences are in a single building. You will see 2-4 Plex when searching for property types a lender will offer loans on.
Articles of Incorporation
The documentation for the creation of a corporation. These documents are filed with the US government and the corporation is formally recognized as an entity in the United States.
Articles of Organization
The documentation for the creation of a Limited Liability Company (LLC). These documents are filed with the Secretary of State where the LLC is created and the LLC becomes a formally recognized registered business entity.
After-repair value (ARV)
ARV stands for After Repair Value. This is the amount that a property will be worth after rehabilitation/renovation.
Borrower
The name of the person, entity, corporation, LLC, etc that is named on a loan.
Bridge loan
Also known as a Hard Money Loan. Bridge Loans are short term loans for property investors who buy homes, rehab/renovate, and put them back on the market within 12-18 months.
Bridge loans have higher interest rates and an average 12 month term, but the loan terms will differ from borrower to borrower based on experience, credit, and other factors.
Capitalization rate
Capitalization rate in real estate is used to measure the length of time it will take for an investment to pay itself off. This amount is found by taking the annual net operating income and dividing it by the cost or value of the property. This rate provides an estimated property value based on net operating income.
Comparables
To determine a sale price, sellers measure similar properties against each other by comparing property characteristics. Factors include square footage, layout, amenities, and additions to the property that make it stand out from other homes. Comparables can also include city housing market research and neighborhood home sale data to increase the amount of usable data.
Entity
A business entity is an organization that exists separately from an individual for tax purposes. In real estate, the most common are Limited Liability Company (LLC), Limited Partnership, or S Corporation. Other entities include Corporations, General Partnerships, and Revocable Trusts.
- An LLC is a business organization that limits the personal liability of its members. It can provide legal advantages similar to a corporation and tax advantages of a partnership.
- A Limited Partnership is a business organization where an individual or party that participates as a minority investor and is limited by legal agreement. A Limited Partnership member can’t participate in any management of the business and only has liability in the capital invested.
- An S Corporation is business organization with 100 or fewer stockholders that decides not to be taxed as a regular corporation. There are other requirements to establish as an S Corporation.
- A Corporation is a business organization that’s formed as a separate legal entity where ownership is proved with stock shares.
- General Partnerships is a co-owned business, with more than one owner, that has not filed papers to become a corporation or LLC. Even if you haven’t filed papers, there will still be city or county requirements that have to be met. You might also have to register a fictitious business name with your county.
- A Revocable Trust is a trust that can be changed depending on the grantor. A grantor is the person who is either the creator of the trust or the options seller. A real estate revocable trust manages assets for the owner over time.
Escrow
Escrow is used in real estate transactions. When purchasing property, a third party receives and distributes funds and/or documents between the primary parties where distribution depends on the agreement between the two transacting parties.
FICO score
The credit score, developed by Fair Issac Company (FICO), that determines a number based off of credit reporting agencies. This score is used to determine borrower risk when loaning funds. Credit scores are calculated using information like the age of credit accounts, payment history, and more. Ranging from 300 to 850, this number affects loan approval, interest rate, and loan terms for the borrower.
Fixed rate
An interest rate that doesn’t change over the course of the entire loan.
Guarantor
A guarantor is a person who guarantees to pay someone else’s debt if the loan defaults. A guarantor might be necessary if someone who has a low credit score is trying to get a loan.
Hard money
Also known as Bridge Loan. Hard Money Loans are short term loans given to property investors who will buy homes, rehab/renovate, and put back on the market within 12-18 months.
Hard Money loans have higher interest rates than a traditional home mortgage and an average 12 month term, but the loan terms will differ from borrower to borrower based on experience, credit, and other factors.
Insurance
A contract that provides financial protection and/or reimbursement for losses paid by an insurance company. There are different types of policies, and property investors may have to obtain different homeowners insurance to qualify for a hard money loan.
Interest rate
An amount charged, as a percentage of the principal loan, to a borrower by a lender. The percentage can vary depending on the loan terms. Every month, the Interest Rate is applied to the principal amount and that sum is added to the total loan.
Loan-to-cost (LTC)
Loan-to-Cost is the ratio comparing the loan amount of the project to the total purchase price of the property. The higher the LTC, the more risky the project will be. A high LTC can affect other factors of the loan and even loan approval.
Loan-to-value (LTV)
Loan-to-Value is the ratio that calculates the value of the loan to the home’s value. You can find the LTV by dividing the loan amount by the appraisal value. LTV is important because a lower LTV rate can result in a lower rates compared to a higher risk LTV.
Net operating income
Net Operating Income is the annual income that is generated from a property. NOI is found by taking the sum of all income and subtracting any expenses. Net Operating Income is also used to find out the Capitalization Rate for a property.
Origination points
A variable percentage that is added to a loan for the work in the loan process by a lender. Origination points can differ based on risk, credit history, and loan amount.
Prepayment penalty
Bridge loans normally have a 12-month term. Depending on the contract, you may not be able to pay off the loan until those 12 months are complete. If you pay before the loan maturation date, you may be charged a prepayment penalty because you paid before the time specified in the contract.
Planned unit development (PUDs)
A planned unit development is a community of homes. These can include single-family homes, condos, and commercial property; but commonly consist of single-family homes. PUDs can also include community amenities like parks, private neighborhood entry, and hired security. PUDs are operated by a homeowners association (HOA) which requires a monthly fee that pays for these amenities and services.
Purchase price
The purchase price is the mutually agreed price between the seller and buyer.
Rehab holdback
A rehab holdback is a process where the rehab/renovation funds are held and then released to reimburse a borrower for documented and approved construction work.
Refinance
A refinance is where you take a current loan and replace it with a new loan with new terms. The new loan will pay off the existing loan. Many homeowners refinance their home to get better interest rates on mortgages.
Renovation
A renovation is when you strip an area down and replace it with something brand new. An example is completely redesigning a kitchen, removing all cabinets, fixtures, and appliances and installing all new cabinets, all new fixtures, and appliances. In the end, the kitchen will have an entirely different look.
Return on investment (ROI)
Return on Investment is a measurement of profitability calculated by comparing how much money was invested into a project compared to how much profit was created after the project was sold.
Return on revenue (ROR)
Return on Revenue is a " measurement of profitability calculated by dividing net income by revenue." Net income is revenue after expenses are subtracted. ROR is useful to determine a company’s profitability.
Single-family residence (SFR)
A single family residence is a home that has no connected or shared walls with another building. It also sits on its own lot.
Update
An update is when you keep existing assets like sinks and cabinets and give everything a fresh look using a new coat of paint or changing smaller things like light fixtures to give the room a new look. The room will largely remain original with only cosmetic updates.
The most common words at your disposal
These words are only the beginning of your fix and flip education. Loan terms will feature many of these words, and knowing what they mean will help you navigate this confusing world. As you gain more experience, you’ll start throwing LTV, ARV, and origination around without a problem.