When you decide to invest in a property, it’s extremely important that you have a solid, fool-proof scope in mind before you move forward. Private lenders will need to review your scope of work, proposed draw schedule, among other important factors, such as the estimated after repair value (ARV). Asset based lenders focus on the numbers of a deal when determining the loan amount they can fund. One of those numbers is the ARV, which is directly tied to two very important numbers for a lender – the Loan to Value (LTV) and Loan to Cost (LTC).
If the renovation plans and costs change midway through a project, it could have a direct effect on the ARV. Because of this, you need to keep your lender in the loop for any alterations you make to your original renovation scope. Removing a wall or altering the floor plan can drastically change the ARV of a property. And if that changes without your lender’s knowledge, it can be disastrous for you and your deal.
Here are a few reasons you should consider before changing your scope during the rehab process:
If you stray from your original plan, you will end up paying more in construction fees, materials, etc. than you had originally planned. Loan modifications are not an easy process, and often impossible. It is unlikely that your lender will approve distribution of additional funds, which means you will have to come up with the money out of your own pocket. This also highlights the importance in having a reserve of working capital in the event there are surprises in your renovation. Excess expenses will hit your bottom line and could dramatically reduce your profit margin.
Some hard money lenders require that you stick with the renovation scope and the approved ARV you presented prior to beginning your project. This could be cause for default and foreclosure. If this is the case, you could face extreme financial implications and a failed deal.
Penalties & Fees
Depending on your lender, changing the scope of a project midway could incur penalties and fees (that stem from default). Check with your lender to understand what fees you may incur by defaulting on your loan.
Loss of Business Relationships
By changing the scope of your project midway, you could risk losing a relationship with your lender all together. Real estate is a relationship business. You can’t put a price tag on a good working relationship with a lender that understands your business. Burning bridges will have a long lasting effect on your success as an investor.
If you do want to make changes midstream, check back next week for tips on how to go about it the right way.