My colleague Bill called me the other day about his client, Sadie. She owns Aunt Sadie’s Salami Deli, and Bill is handling her 7(a) loan application. Now, Sadie also owns a single family residence that’s undergoing renovations that won’t be complete for months. Bill was trying to determine how much equity the residence has, as that will determine whether to put a lien on the property. How would SBA calculate the equity on a residence under construction?

As Noah said getting off the Ark “Wow!  There’s a lot to unpack here!” Let’s begin at the beginning, which I have always found is an excellent place to begin:

Beginning at the beginning. Some SBA lenders think that every 7(a) loan requires a lien on the principal’s residence. Bill’s an experienced 7(a) lender and knows that’s just a myth. But like every myth there’s a reality somewhere backing it up. In this case, the reality is that a 7(a) loan must meet SBA’s definition of being fully collateralized. Bill did his calculations and determined that the loan application did not meet that definition and that there was a collateral shortfall.

So he had to lien the available equity in aunt Sadie’s residential real estate. An exception could be made if the loan file had documentation that the equity in the real estate was less than 25% of the property’s fair market value. But since the residence was being remodeled, would the equity be determined by an “As Is” Appraisal or an “As Complete” Appraisal?

The rest of the story. You’d expect the lender for Aunt Sadie’s home remodeling to have a file containing an appraisal stating both the “as is” and the “as complete” values, as well as documents giving the lender the right to finish the construction so as to obtain the “as complete” value if Aunt Sadie bellied up. But maybe Aunt Sadie is paying cash for the renovations and there is no remodeling loan. Or maybe another lender is financing the remodeling.

In any case, the 7(a) loan is not financing the remodeling. So the 7(a) lender has no control over how funds are spent to achieve the “as complete” value. The only value the 7(a) lender may rely on is the value right now: the “As Is” value. When you think about it, doesn’t that make sense?

And the SOP says? … It’s a dilemma. While the SOP is silent on the issue, this statement on page 489 should give us some direction: “SBA has no specific appraisal requirements for non-commercial real estate (such as a residence) or real estate (commercial or non-commercial) taken as collateral to secure a personal guaranty.”

Based on this, and everything I’ve read, it’s my opinion that the property value is to be considered “As Is: Fair Market Value.” To me, that indicates the current condition. I know we’re not talking specifically about securing a personal guarantee here, although yes if we take the house as collateral, we’ll need a personal guarantee.”

If the 7(a) loan goes bad—which is why we’re talking about the house as collateral anyway—SBA will want to collect right away against the collateral and won’t want to sit around until some contractor completes remodeling the house of a potentially insolvent Aunt Sadie.

Here is a maxim on which you may rely: “SBA does not give present effect to a future event.”

Or as Aunt Sadie would say, “Don’t call it a salami sandwich until it’s on rye. With mustard and mayo.”

Richard Jeffrey
Senior Associate
Head Underwriter