When you come to Rehab Financial Group, LP (“RFG”) for a rehab loan, you will present us with the scope of work (“SOW”) for the property. This SOW will include all of the changes you intend to make to the property from major changes such as the adding of square footage and finishing a basement, to smaller changes such as replacing a few windows or adding a fence.
The SOW you provide is sent to both the appraiser and inspector looking at the property for the appraiser to develop an “after repaired value” (“ARV”) and for the inspector to validate that the cost for the work being done is reasonable and that all major items needing repair are addressed by the SOW.
Prior to closing, your SOW and the inspector’s review and comments are reconciled and an agreed upon repair list is decided on. In most cases, the borrower follows the agreed upon SOW and there are no issues between the borrower and RFG with regards to draw releases during the rehab process and when the rehab is finished. Problems arise, however, when the borrower decides unilaterally to change the scope of work during the rehab process without informing either RFG or the inspector that such changes are being made until the project is finished.
Why Is It a Problem When SOW Changes are Not Communicated?
Simply put, it is a problem because the borrower is not producing the product that the lender based the amount of the loan on. By materially changing the SOW, the property may not have the ARV expected due to the borrower’s post-closing changes. For example, RFG recently had a loan where the SOW provided for $15,000 to finish the basement. This property was a small, urban row home, where interior square footage was limited. The borrower decided not to finish the basement in order to save money. The problem was, however, that the ARV was based on a finished basement, which would have provided an additional 850 square feet of below grade living space. The house was now worth less than the projected ARV and the borrower was unable to receive his final draw amount as expected.
The information had to be sent back to the appraiser to revalue the property without the finished basement. The borrower had to pay for this and ultimately, the ARV was lowered. RFG only released part of the funds remaining in the rehab account and used the remainder to pay down the loan, keeping the loan amount in conformity with the necessary loan to value ratio.
In another example, money was allocated to replacing the siding of a home but the borrower decided to paint it instead. Not having new siding reduced the value of the property and the same scenario as above took place.
These types of situations stress the relationship between the lender and borrower. At RFG we strive to deliver excellent customer service and work with our borrowers, but we also have a duty to protect our investors and lenders. No lender, including RFG, is going to give a borrower issues on small changes, such as using hardwood for flooring instead of carpeting, but major changes that change the ARV and desirability of a project are a significant problem.
We try to stress that the agreed upon SOW is set in stone and cannot be materially altered during the course of the project. It is a fact of life, however, that sometimes circumstances change causing a need for changing the SOW.
How Should Changes to SOW be Handled?
It is important that the borrower involve the lender as quickly as possible BEFORE making the changes. That gives the lender the chance to work with the borrower to rework the existing SOW before the funds are spent and to address any valuation changes with the appraiser before being presented with a finished property different from what was expected. This will give the borrower the opportunity to decide whether they want to move forward with the revisions once they know changes to ARV and whether the lender will release all of the rehab funds anticipated. It is important for the borrower to realize thought, that any post-closing changes to the SOW will involve the expense of getting the inspector and appraiser to re-evaluate the economics of the project.
Knowledge is a powerful tool. Both the borrower and lender need to be informed and aware of changes made to the SOW that will ultimately affect the ARV of a property. Waiting too long to get the lender involved can result in disappointment on the borrower part and stressing of the relationship between borrowers and their lending partners.
Rehab Financial Group stays laser-focused providing knowledgeable, responsive customer service to all our customers. This includes helping all borrowers maximize their investments. Through comprehensive communication with the RFG team of loan experts during the loan approval process, borrowers can avoid the unwanted negative impact of SOW changes during their project. As changes to the SOW are discouraged and present challenges, there are rare instances when it is necessary and makes sense. In these cases, it is important to work with your lender. This approach helps ensure that the profit goals of the investor are attained for every project.