ARV and the 75% rule

Why your loan is smaller than you expected

A borrower sends a deal: $310,000 purchase, $85,000 rehab, and an after-repair value they are confident about at $560,000. They have been told 90% of purchase and 100% of rehab, so they are expecting $364,000 and a $31,000 cash requirement.

They get a term sheet at $364,000. It works, comfortably. Now change one number, the purchase price is $390,000 instead of $310,000, and the same lender comes back at $420,000 against a request of $436,000. Nothing about the borrower changed. The budget did not change. The ARV did not change.

What changed is which of the three constraints is binding.

The three constraints

Every fix and flip loan is sized by three separate tests, and the lowest of the three is your loan amount. Not the average. The lowest.

1. A percentage of the purchase price. Up to 90% for an experienced sponsor, lower for a first project. This is the one everybody quotes.
2. A percentage of the rehab budget. Up to 100%, held back and released by draw as the work is completed.
3. A percentage of the after-repair value. Typically 75%. This is the one that actually binds most deals, and the one borrowers forget.

Run the first example. Purchase advance: 90% of $310,000 = $279,000. Rehab: 100% of $85,000 = $85,000. Total: $364,000. Test three: 75% of $560,000 = $420,000. The ARV ceiling is above the request, so the request stands.

Now the second. Purchase advance: 90% of $390,000 = $351,000. Rehab: $85,000. Total request: $436,000. But 75% of $560,000 is still $420,000, and $420,000 is lower, so that is the loan. The borrower brings the difference.

The 75% rule is a risk calculation, not a convention

It is easy to read the ARV cap as an arbitrary lender rule. It is not. It is the lender pricing the distance between your loan and a forced sale.

A property that appraises at $560,000 finished does not sell for $560,000 in a hurry. Sale costs run 7 to 9% with commission, title and concessions. A motivated sale in a soft month prices below the appraisal. Add accrued interest and the cost of finishing a project somebody else abandoned, and 75% of ARV is roughly where a lender gets made whole in the bad case, which is the only case that matters when you are setting the cap.

It also protects you. A deal that only works at 85% of ARV has almost no margin for a two-month delay or a 5% miss on the sale price, and those are the two most common things that happen.

What actually sets the ARV

Yours is an input. The appraiser’s is the number the loan is sized against.

An ARV appraisal values the property as if the described renovation is complete, supported by closed comparable sales of similar finished properties in the immediate area. Three things move it, and all three are within your control:

• The comps you supply. Recently closed, genuinely comparable in size, beds, baths and condition, and genuinely nearby. An appraiser will find their own; giving them the right three saves an argument.
• The scope you document. The appraisal values the described work. If the budget says “cosmetic refresh” and your comps are gut renovations with new kitchens, the value will not follow.
• The ceiling of the street. If nothing on the block has ever traded above $520,000, an appraiser will be reluctant to sign a $560,000 opinion however good your finishes are. This is the single most common reason an ARV comes in short.

Where the budget gets adjusted

The other place a term sheet moves is the rehab number, and it usually moves up rather than down. A budget that is visibly light for the described scope gets adjusted in underwriting, because an underfunded project is a default with a delay on it.

What a credible budget looks like: line items by trade, with quantities and costs a general contractor would recognize. Contractor bids where you have them. And a contingency: 10% of hard costs is reasonable, and its absence is noticed.

Sizing a deal before you write the offer

Work the third test first. It sets your maximum allowable offer.

1. Take the defensible ARV: the number your comps actually support, not the optimistic one.
2. Multiply by 0.75. That is the most the loan can ever be.
3. Subtract your rehab budget. What remains is the maximum purchase advance.
4. Divide by your purchase advance rate (0.90 if experienced). That is the highest purchase price at which you bring only the expected equity.

On a $560,000 ARV with an $85,000 budget: $420,000 − $85,000 = $335,000 of purchase advance, and $335,000 ÷ 0.90 = roughly $372,000. Above that price, every dollar comes out of your pocket rather than the loan.

Investors who run that arithmetic before writing offers stop being surprised by term sheets. It is four lines of math and it is the difference between a deal that funds and a deal that reprices.

One more thing the numbers do not show

Do not budget only for the down payment. Plan for closing costs and fees, the carry until the first draw clears, and reserves after closing: enough to hold the property for several months if the project runs long, because projects run long. The lender is looking for that too, and it is the quietest reason a strong file gets a smaller loan.

If you want a number on a specific deal, send it over. A credit officer will run all three tests and tell you which one binds.