When refinancing a property shortly after purchasing it, i.e. within the past three to twelve months, in some cases, DSCR Lenders will require documented proof of the cost of the improvements. This is especially common in BRRRR (Buy, Rehab, Rent, Refinance, Repeat) strategies, where the investor’s goal is to increase the property’s value through renovations and then pull out cash via refinance. Depending on the specifics of the loan, particularly the seasoning (how long between property purchase and date of refinance) and whether the refinance is a cash-out refinance or not, the DSCR Lender may use the cost basis of the property (i.e. the purchase price plus the amount of money spent on renovations) as the applicable value (i.e. value utilized in the all-important LTV calculation).
More commonly however, is that DSCR Lenders will require this “documented improvements” documentation to provide additional certainty of value and fraud avoidance for cases in which the market value of the property is deemed to have increased significantly in a short period of time. While significant increases in value are not uncommon in cases of smart rehabs and under-market buys, cash-out refinances based on a quick and steep increase of estimated value are the most common source of fraud facing mortgage lenders, and this DSCR Loan documentation requirement comes primarily from that consideration. Proof that the applicable value-added renovations occurred and significant capital was invested in the property can prevent fraudulent cash-out refinances, as fraud schemes based around an inflated estimated market value are significantly harder to pull off if the specific improvements (renovations, fixes) and their costs are required to be provided.
The good news for borrowers in situations where documented improvements are needed is that the requirements are relatively light and straightforward. Because it’s primarily a fraud-prevention measure, or just to provide some extra comfort around a valuation (rather than a true investigative analysis of the renovations value-add budget and execution), most DSCR Lenders will not require too extensive of documentation like detailed scopes of work or sophisticated budgets and plans. Rather, investors generally just need to provide a list of renovation items and costs and typically only needing to provide full invoices and detail for big-ticket items (such as a $5,000 hot tub installation or $10,000 turf implementation). Generally, lenders won’t require full receipts and proof of payments for every little thing and will generally accept general documentation that lines up with appraiser comments and pictures. However, these should be limited to items legitimately used for adding value, and not incidental things such as electric, water or wi-fi bills in place during the construction period or similar grey areas. If you have any specific questions, these can easily be sent to the DSCR Lender and confirmed prior to submitting the documentation, or even just worked around without a back-and-forth if the overall renovation documentation file is clean and easy to follow.
Even though this documentation requirement isn’t too stringent, that doesn’t make it a good idea to be loose or sloppy with providing this information. Borrower best practice is to have documented improvements information as organized and clearly labeled as possible and to avoid playing games with exaggerating costs or fudging numbers. Indeed, since this is more of a fraud-prevention measure than detailed lender exercise, anything inconsistent or hard to decipher will raise red flags and turn what should be a box-checking exercise into the DSCR Lender taking a closer look and considering if there are extra risks involved.
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