While many describe the process of construction as organized chaos, the funding of construction requires absolute organization. To receive funding for a construction loan, a contractor must submit an extraordinary amount of paperwork and undergo a thorough review process. Once the bank or credit union approves the funding, the contractor must again submit a construction draw request and undergo an extraordinary amount of paperwork and undergo a thorough review process to receive the funds.
Items in a Construction Draw Request
Because the large amounts involved in a construction loans, lenders do not disbuse the funds all at once. Instead, lenders issue the funds of a construction loan in phases. The funds are distributed are usually tie to milestones or within specific intervals of the project. When the builder or owner has reached those milestones, he or she will submit a construction draw request. The process ensures the lender and the builder undergoes due diligence throughout the project.
1. Request for funds
The builder submits a construction draw request in order to receive funds from the loan. Usually the builder has completed work, and the project has reached a certain payment milestone as indicated in the loan paperwork. With work completed, the builder has several invoices that require payment. Materials from suppliers along with subcontractors labor must receive payment soon. Then the builder can move forward onto the next phases of the project.
2. Documentation of project changes
Changes on a project can get out of control. When builders do not document project changes diligently, it’s easy to receive surprises at the end. Again, the documentation required on a construction draw is quite intense. Therefore, when the builder submits the construction draw request it must include details concerning the change. Additionally, any variance whether it resulted in an increase or decrease to the budget.
3. Track finances and progress
When submitting a construction draw request, the builder must include invoices and receipts. Project expenses are tied to itemized list of work completed serves to validate the expenditures. With payments tied to completed work, the lender and builder are both able to track money spent to progress. Were we billed accordingly? Are line items increasing or decreasing? The builder can track how the project is financially progressing.
4. Maintain accountability
The documentation involved within a construction draw request upholds a sense of transparency among the builder. Tracking changes and expenses diligently within the project limits the surprises at the end. How did we run out of money? All parties become aware of how the funds are being used and if they are being used appropriately. The lender has a responsibility to protect its financial interests, the construction project, and is holding the builder accountable.
5. Lien releases
It is critically important that all the suppliers and subcontractors receive payment in full. If not paid in full or in the event of any payment disputes, they have the right to file a mechanics lien on the property. Tracking payments and ensuring lien releases provides a clean title at the completion of the project. Some lenders can make payment directly to the subcontractor or supplier. This ensures that any firms who have filed a lien have received payment of and have waived the right to claim a lien in the future.
6. Third-party inspection
No lender will disburse funds from a construction draw request without a construction draw inspection. The lender is not an expert in construction, so they will usually employ a third-party to conduct the inspection. The inspector will not evaluate the quality of the work nor ensure that the work meets any required permits or codes. However, the inspector verifies that builder has completed the work indicated on the construction draw request. Additionally, the inspector evaluates the progress of the construction project against the draw request.
7. Updated title insurance
Once the construction draw request has been disbursed, the title insurance must be updated accordingly. Because the work completed has increased the value of the building, insurance coverages must be increased as well. The title insurance reflects the total amount of funds disbursed to date.
As you can see, the amount of items reviewed in a construction draw request are quite detailed. Construction loans pose an enormous amount of financial risk for a lender. It is part of their due diligence that the funds disbursed are utilized in the manner as stated under loan provisions. The borrower and builder are in a long-term partnership with the lender to ensure the funds are utilized judiciously. Documentation of project changes and financials to ensure financial transparency and accountability.