The after repair value is the value of the home after the renovation has been completed. This number is also the single most important number in the whole underwriting process. If a fix and flip deal passes the after repair loan-to-value ratio test, a lot of flaws in the deal can be overlooked.
Okay, so what must the loan-to-value be based on the after repair value? For most fix and flip lenders, this ratio must be 70.0% or lower. Many fix and flip lenders will not exceed 65% of the after repair value.
Ultimately the after repair loan-to-value test is a measure of the profit in the deal and of the wisdom of even doing the deal at all. At a recent conference, several fix and flip lenders reported that they had had investor-flippers actually thank them for turning down their deals because the projects lacked profitability. The appraiser and the lender had caught a big mistake that the investor-flipper was about to make. In several cases, the investor-flipper was able to go back to the seller, show him the numbers, and convince the seller to lower his asking price!
I hinted earlier that some flaws might be overlooked if there was a enough potential profit in the deal. For example, normally a fix and flip lender will require that the investor-flipper contribute (put down) 20% of the purchase price of the run-down home. If the after repair loan-to-value ratio was less than, say, 65% then the investor-flipper might be able to convince his fix and flip lender to allow him to put down just 15% of the purchase price of the run-down home.
If the project has lots of potential profit, in other words, the after repair loan-to-value ratio is less than 65%, the investor-flipper might get approved with a credit score of less than 600 or with better credit but with no experience. No matter the size of the potential profit, it is unlikely that the investor-flipper would be approved if he both lacked experience and had poor credit. Potential profit can only do so much to help.
I just finished an extended article on fix and flip loans, and I encourage you to read it. The guys making the big money in finance these days are the ones either using fix and flip loans or originating them. Fix and flip financing is a target of hot money on Wall Street.