WHY DO LENDERS USE DRAW SCHEDULES?

Understanding how lenders do business is important. The entity that is granting you a loan has a lot of control over the way that you handle your construction project. If you are working in the construction industry, you need to be sure that you understand the loan process so that you are able to secure loans that work well for your specific project planning goals.

The construction loan draw process minimizes risk for lenders, but it can change how you work on a job. Keep reading to find out what a draw schedule is and why lenders use this model of releasing funds for a project. This is a common method of managing construction loans, and anyone in the industry should be familiar with it.

What is a Draw Schedule?

Construction loans are not usually immediately advanced in full like some other loan types. A draw schedule explains how the funds for your loan period will be dispersed. Typically, the funds are released in milestone payments at specific intervals throughout the job. Different amounts can be released for each stage of the project, and certain milestones in the work on the job might need to be completed before more money is disbursed.

As an example, many jobs will require that some cash be released to get the job started. This money will be used for site prep, hiring staff, etc. The money will be dispersed once the lender can prove that the proper site prep has begun. Usually, clearing and leveling are necessary to be able to get access to this first draw.

The second draw will be for the foundation and for inspections, as well as other prep work necessary to get the foundation of the building set up correctly. A third draw might be framing and roof installation, a fourth for things like interior work and HVAC installation, and a final draw for finishing work.

The draw schedule can vary depending on the job type, the amount of money that is included in the loan, and other variables. You need to be sure that the draw schedule is going to work with your construction plans and needs as well. This is something that can sneak up on those who are handling a large construction project because they didn’t ask enough questions about how the loan would function when they were securing it.

You should be willing to ask questions to clarify anything that you don’t understand about the loan that you are seeking. It’s important to know how your loan works and any limitations that will be placed on your project related to its funding.

Why Do Lenders Use Draw Schedules?

There are some important reasons that lenders use draw schedules for construction jobs.

1. Risk Mitigation

Construction loans are much higher risk to lenders than some other loan types. These loans are not secured by items that are easy to sell to recoup losses, and there are lots of variables that can impact whether a construction job is completed on time or properly. Lenders want to disperse money in stages and after certain milestones are met in the project, so that they are sure that the project will continue to completion.

2. Verification of Work

Lenders can only assume that a project will not be completed if there are issues with milestones associated with the work that is being done. While some delays cannot be avoided, consistent problems with completing the necessary work to finish a construction project can make lenders nervous. You will have to meet certain requirements to get your additional funding, and you shouldn’t be surprised if a lender does not give you your next draw until you are able to prove that your project is on track.

3. Budget Control

Budgets can be quite large and complex in construction work. Lenders don’t want to give out the entire sum of a loan right off because they are hoping that dispersing it slowly will ensure that the project’s budget stays on target. There is more risk for budgeting issues when the entire sum of the loan is dispersed all at once.

4. Lien Protection

Draw schedules are ideal for banks because they usually include lien waivers from subs involved in the work on the job. This means that it’s more likely that everyone will be paid, and the risk of a lien on the property is reduced as well.

5. Efficiency

Draw schedules keep loans and construction jobs on target. It’s really easy to lose track of the milestones that need to be completed to get a job done when there aren’t any milestones that have to be met to finish the job. Draw schedules can sometimes keep things on target for everyone involved in the process of the job and the loan dispersal itself.

Draw Schedules Are Very Common in Construction Lending

If you work in the construction industry, particularly on large jobs, you will need to understand how draw schedules work. This is a fairly simple type of loan to work with, and many construction professionals will have a draw schedule in place for all of their projects. Draw schedules protect lenders and projects alike and can be the right way to ensure that everyone gets paid and that the job gets completed. If you are applying for a construction loan, you should expect to have a draw schedule in place for the loan.

Now that you understand this type of loan, you can plan for your loan dispersal to operate in this fashion. Being prepared for how the money will be handed out during the life of the loan can help you to plan out your project the smart way. You should expect to be required to meet specific milestones, and you need to ask what those milestones are before you agree to have the loan funded. The more you understand about the loan that you are signing up for, the easier it will be to access its benefits and funding during the work that you need to complete.

Source: Guest article received by email from Gabe (The Mortgage Reports).