For most construction projects there are typically 4 draws where money is advanced against the construction mortgage approval to pay for construction costs incurred to the defined draw point. The number of draws can vary for type of project, but for residential projects as an example, 4 draws are most typical.
While everything tends to be well laid out prior to construction commencing as to what needs to be completed for each draw, what happens in reality when you get to each draw request can be quite different from the plan.
This is especially true of institutional construction loans where the draw amounts need to be approved once the mortgage lender reviews the completion report provided by a third party appraiser. The role of the appraiser is to assess the remaining amount of work needed to complete the project and in many cases tend to be more conservative than what is actually required. The result of an overly conservative appraisal will likely see the lender reduce the draw request to make sure there are sufficient funds available to complete the project.
If a draw reduction occurs, the project is now put into a position of having to come up with another source of cash to get everything paid up to date and keep the overall project on track.
This is one of the potential challenges with any type of construction loan, but more common in the case of those issued by an institutional or traditional lender.
With private lenders, draws can also be cut back, but this is more likely to occur when required work elements defined for a particular draw are not completed. Private lenders don’t tend to perform cost assessments on the remaining work and are more concerned on the work done to date as compared to the building plan and time line they agreed to fund for each draw at the time of construction loan approval.
Another draw management challenge is the amount of hold back and eventual hold back payment. While the required hold back amount is 10%, institutional lenders tend to hold back as much as 15% of the total project costs. And at the end of the project when the hold back period is completed, the only way to get access to the hold back portion is through a long term take out mortgage with the same lender.
Private lenders tend to stick to the 10% hold back amount and will typically disburse the hold back at the end of the project when the hold back period has passed without any claims being made against the project.
There are other draw management issues to consider as well, making it one of the more challenging and potentially nerve racking aspects of construction project management.
For more information on how to effectively manage construction mortgage draws, click here to speak directly with construction mortgage broker Joe Walsh