Flipping Houses

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There has been a lot of controversy over the term “Flipping”. Is it illegal or not? The bottom line is no, it is not illegal. What’s illegal is mortgage and appraisal fraud.

Here is a quick overview about why the term “Flipping” has received such a bad rep:

This all started back when some investors, realtors, mortgage brokers and appraisers got together and designed a plan to make some quick cash in real estate. First they found a buyer that would qualify for a 75% - 90% mortgage with decent credit. They would give the buyer a list of properties that was in the price range of what the buyer could afford. They told the buyer to go and look at the properties on the list and once the buyer found one he/she liked, the investor/realtor would go and make an all cash offer at a small discounted price; a price that would, more than likely, be accepted by the seller.

Once they got that property under contract from the seller, they would turn around and sell it for about 20% or so over the true market value of the property. The appraiser would then appraise the property at the over inflated price. The mortgage broker would write up the mortgage at the percentage that the buyer would qualify for and the investors/realtor would end up carrying back a second.

In short, here’s what happened in these types of transactions:

Let’s say the buyer could qualify for an 85% first mortgage. The investors would find a property that was truly worth $100,000 after it was fixed up but was maybe listed for $80,000. They would try and get the property for $60,000 - $75,000. Maybe the investor would even spend $3,000 - $5,000 for clean up, fix up and paint the property. They usually would not do a great rehab job on the property. They would then sell it to the buyer for $120,000 with the seller/investor paying the closing cost for the buyer. This way the buyer could get into the property with nothing down.

The appraiser would then appraise the property for the $120,000 purchase price and the buyer would get a first mortgage of say 85% or $102,000 and carry back a second of $18,000 with every intention of forgiving the second mortgage.

If the investor paid the closing cost of $4,000 for the buyer and had $5,000 in cleanup and fix up costs, they would have spent about $9,000. They would conduct a simultaneous closing with the seller and buyer.

The seller would get their $60,000. The investor/realtor would recoup their $9,000 and would end up with a profit of about $33,000. As far as they were concerned, the property was only financed at about 100%. The problem is, the buyer was only qualified for 85%. They took the money from the loans and usually forgave the second mortgage as a bad dept and were able to write them off their income taxes to offset the income they made from the transaction.

Here’s where the problems started:

Many of these buyers never made their first mortgage payment and there was a high record of first payment defaults. The lenders started to check into this issue and discovered all the fraud that was taking place with the over inflated appraisals and the second mortgages that were being written off. They also discovered the poor condition of the properties. Even though the investor made some improvements to the properties, they never fixed them up to meet the appraisal.

Because this all occurred through simultaneous closings, the media termed it “Flipping” which is what it was. The problem was the fraud, not the fact that the property was flipped.

After this became an issue, the mortgage industry decided to change their rules so that this would not happen to them in the future. They started requiring seasoning of ownership. This created a problem for the honest rehabbers in the business.

If a rehabber bought a property for say $60,000, put $20,000 into rehabbing it and sold it 4 months later, the lenders would not finance the new buyer. That hurt a lot of investors because they needed to get their money out of the property to start the next rehab; now they had to wait another month or two to be able to sell it so that the lenders would feel comfortable giving the buyer a new loan.

FHA was one type of loan that did not require the seasoning of ownership. However, now they do. They are also requiring a 90-day minimum ownership before they will allow an FHA insured loan to be placed on a property.

Click Here to read the news release from FHA on this issue.

For the most part, the “Flipping” issue has settled down and a lot more lenders are relaxing their rules and guidelines for seasoning. They are requiring that you document the condition of the property when you buy it and the work that was done to the property. I actually think this is a good thing. It will force rehabbers to do a good rehab on the properties and weed out some of the bad investors in the business.

I still “Flip” properties today; there is nothing illegal about flipping a property. Don’t commit fraud! Document your transactions and everything will work out ok.

We should start using a different term for the word “Flipping”. I have been starting to use the term “Quick Turn”, that’s from Ron LeGrand.

Wholesaling properties is also a “Flip”. The term “Wholesaling” sounds a lot better today than “Flipping”. There are many ways to flip (I mean “Quick Turn”) a property and there are many advanced, creative real estate strategies that don’t require quick turning properties.

One of my favorites is to “Slow Turn” a property. I sell the property on terms, whether it is a Lease with Option or a Contract for Deed. By the time your buyer gets a new loan to cash you out, the seasoning issue is no longer an issue.

Happy Investing,

Mike Jacka

www.realestatepromo.com

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