Construction Loan Draws Explained
Construction draws are an important aspect of any construction project that is financed by a third party. Construction loan draws, or simply loan draws, are the progress payments you'll receive throughout a construction project to reimburse you for materials delivered and hours worked, culminating in the final payment and return of retainage.
Before You Begin: The Construction Draw Schedule and Schedule of Values
The draw schedule is always established in the construction contract and can be anything from five to seven discrete payments or draws once or twice each month. A typical draw schedule might be based on milestones (such as laying the foundations or building the frame) or may be based on the percentage of project completion. Either way, establishing the draw schedule up front increases confidence that payments will be made in a timely manner rather than having to wait for payment after the entire project is complete.
When the initial contract is drawn up, you will create a schedule of values, which is the estimated project budget. The construction lender may have this schedule assessed to see whether the values are reasonable for the area and kind of construction before approving the construction loan. Once the loan is approved, you will create a draw schedule together with the owner and the bank. The schedule will include the frequency of payments and the dollar amounts of each draw.
The Loan Draw Process
To make a draw request, you will present documents that show the work completed and the costs incurred. Typically, the draw request package includes:
A draw request form. This is a form provided by the construction lender (usually a bank) that includes the name of the title companies, the dates of the draw period, and the line-item and total amount of the draw request. The owners, contractor, and bank all sign off on this form.
Invoices and receipts. In the draw request package, you will include all of the invoices and receipts for materials delivered, W-9s, terminations, and invoices from subcontractors to substantiate your costs.
Your updated schedule of values. The cost breakdown that you prepared at the start of the construction process will be submitted with each draw request showing updated (actual) values for the work completed so far and the estimated values for the work that is yet to complete.
Any change orders. Whenever there is a change to the schedule of values (either on the part of the contractor or the property owner), the person requesting the loan draw must submit a change order detailing the addition, deletion, or change, along with any additional time and material costs incurred. Some lenders will pay for change orders and others won’t, which is why it’s important to make your initial bid as accurate as possible.
A description of project progress. Together with the draw request form and substantiating documentation, you will present an overview of completed work, including milestones reached or a checklist of items yet to complete in order to reach the next milestone.
Lien waivers. When applying for construction draws, you may be asked to include a lien waiver for the current draw period as well as previous draw periods. These will usually be conditional, coming into effect once the payment has been made. The lender will also check that no liens have been filed by subcontractors or suppliers against the primary contractor, as these can also cause problems for the lender.
After presenting your draw request, the lender will look over the paperwork to see whether the actual construction costs match the payment amount that is being requested. The lender—or a title company—will then conduct a draw inspection at the job site and write up an inspection report confirming the progress described in your overview.
How Long Does the Draw Request Process Take?
A typical review process can take seven days to complete, though the timeframe is sometimes significantly longer. Having a construction accountant prepare the draw package and make sure everything is in order is one of the best ways to speed up the approval process, as requests for additional paperwork can extend approval times.
Retainage in Construction
When the progress payment is eventually made, 5-10% will usually be held back as security for the owner. This is referred to as construction retainage. Retainage funds are usually paid upon project completion or at the point of substantial completion—usually defined as the dwelling being fit for use (even if there are a few loose ends).
Can a Construction Draw Be Charged Ahead?
Understandably, construction lenders and property owners want to pay for completed work. They don't want to pay ahead as this would present a risk to both the owner and the lender (i.e. you may take the forward payment without completing the work). This can cause cash flow challenges for the primary contractor, which is why it's essential to have a solid cash flow management strategy in place.
A general contractor can, however, expect to be paid a small deposit at the beginning of new construction projects. This requirement varies by state. With construction lending for a project in Jacksonville, Florida, for example, you could expect to receive 5-10% up front as a down payment, which can help you cover the initial costs of labor and materials for the first stage.
What If the Construction Project Ends Up Costing More?
When borrowing money, a property owner will calculate a construction loan amount that covers:
The construction site (if not owned outright)
The soft costs, such as conveyancing and building plans
The cost of construction, based on the schedule of values
If there are cost overruns (which there usually are), the responsibility for the additional costs will depend on the reason for the overrun. If the company underquoted in the initial construction budget, the company will usually have to cover the difference in cost. However, if the property owner changed his or her mind—opting for more expensive floor tiles or adding a stairlift, for example, it is the property owner's responsibility to cover these costs.
Tips for a Smoother Payment Process
As a construction company or general contractor, it's in your best interest to be paid promptly for work completed. Having your draw requests approved quickly will also provide capital to continue the work, which is in the best interests of all parties involved. The following tips can help you work with the owner and lender for a smoother payment process.
1. Create a Draw Schedule Based on Milestones, Not Percentage of Completion
When creating draw schedules at the start of a construction project, shape them around milestones rather than a percentage of completion. Milestones—such as laying the foundation or plastering—are easy to check and confirm, whereas the “percentage of completion” leaves room for doubt and may lead to payment delays.
2. Involve a Construction Accountant to Give More Accurate Quotes
As your construction budget often can't be increased after approval of the loan, it's critical to get your quote right the first time. A construction accountant can help you prepare more accurate quotes based on previous projects and similar construction projects in your area.
3. Complete Each Stage in a Timely Manner
When you begin a build, the owner will usually be required to submit a Notice of Commencement, after which the clock starts ticking for construction progress and loan draws. According to Fla. Stat. § 713.13 in Florida, for example, owners are instructed not to make any payments after the Notice of Commencement expires.
4. Keep Accurate Records of All Expenses Incurred
There are a lot of pieces of paper to keep track of when you're working on a construction project (materials, equipment, delivery, labor, PPE, laundering, lunch, insurance, etc.), and it can be easy to let some slip through the cracks. Using construction bookkeeping software or investing in outsourced bookkeeping can help ensure that you can claim all of the actual costs you incurred.
5. Submit Each Draw Request Package On Time, Making Sure It's Complete
Once your paperwork is in order, preparing the substantiating evidence for each draw request will be much quicker and easier. Rather than taking time out of your construction work, you can prepare each draw package as you go. Then all you'll need to do is fill out the draw request form, write an overview of the work completed, and submit the completed package for review.
6. Manage Your Cash Flow with a Capital Fund and Expert Cash Flow Planning
Knowing that you'll only be paid after each stage of a construction project is complete, it's essential to have the capital to finance the first stage of each new project up-front. A professional accountant can talk you through your options for construction capital, including loans, savings accounts, and interest-bearing investments. The aim is to start on the front foot—rather than the back foot—and have reserves so that you can work stress-free.
Approach Construction Loan Draws with Confidence
While they take a bit of time and organization, loan draw requests are nothing to be afraid of.
Before signing a construction contract, take the time to learn the terms and preferred schedules of the lender, prepare an accurate and realistic quote (with room for margin), and follow these tips for easier bookkeeping.
When it comes time to present your progress report with invoices and receipts, you'll have everything you need to get paid.
