Loan Draw
A loan draw is a disbursement of funds from a construction or rehabilitation loan, released in stages as specific project milestones are completed and verified by inspections.
Key Takeaways
- Loan draws are incremental disbursements of funds from a construction or rehab loan, tied to project progress.
- Each draw typically requires an inspection to verify completed work and adherence to the project budget and scope.
- Effective management of the loan draw schedule is crucial for maintaining project cash flow and avoiding delays.
- Lenders often retain a holdback percentage from each draw to ensure project completion and address potential liens.
- Understanding the draw process is vital for investors undertaking fix-and-flip or new construction projects.
What is a Loan Draw?
A loan draw, also known as a construction draw or progress payment, refers to the incremental release of funds from a construction or rehabilitation loan. Unlike traditional mortgages where the full loan amount is disbursed at closing, construction loans are typically structured to release funds in stages. These stages are tied to the completion of specific project milestones, ensuring that the funds are used as intended and that the project progresses according to schedule and budget.
How Loan Draws Work
The loan draw process is a critical component of financing real estate development and renovation projects. It involves a structured approach to fund disbursement, protecting both the lender's investment and the borrower's project integrity. Each draw request typically follows a predefined schedule, which is often outlined in the initial loan agreement and tied to a detailed project budget.
Key Components of the Draw Process
- Draw Schedule: A pre-approved timeline and budget breakdown detailing when funds will be released for specific phases of work, such as foundation, framing, plumbing, or finishes.
- Inspection: Before each draw, the lender typically sends an inspector or appraiser to verify that the work corresponding to the requested draw has been completed satisfactorily and is lien-free.
- Documentation: Borrowers must submit invoices, lien waivers from contractors and suppliers, and other relevant paperwork to justify the requested funds.
- Holdback: Lenders often retain a percentage (e.g., 10-20%) of each draw until the project is fully completed and all final inspections are passed, ensuring against potential issues or incomplete work.
Real-World Example: Fix-and-Flip Project
Consider an investor securing a $200,000 hard money loan for a fix-and-flip project with a $150,000 renovation budget. The lender approves a draw schedule with five stages:
- Initial Draw (Purchase & Demolition): $30,000. Released at closing to cover property acquisition and initial demolition costs. No inspection needed for this first draw.
- Second Draw (Framing & Rough-ins): $45,000. After framing, electrical, and plumbing rough-ins are complete. An inspection confirms the work before funds are released.
- Third Draw (Drywall & Exterior): $40,000. Once drywall is hung and exterior work (roof, siding) is substantially complete. Another inspection is required.
- Fourth Draw (Finishes): $35,000. For flooring, cabinetry, paint, and fixtures. Inspection verifies these interior finishes.
- Final Draw (Completion & Punch List): $0 (remaining $150,000 - $30,000 - $45,000 - $40,000 - $35,000 = $0). This final draw releases any remaining holdback funds after the final inspection, certificate of occupancy, and all lien waivers are submitted.
This structured approach ensures that the investor only receives funds as work progresses, minimizing risk for the lender and encouraging timely project completion by the borrower.
Frequently Asked Questions
What is the primary purpose of a loan draw?
The primary purpose of a loan draw is to disburse funds for construction or renovation projects in controlled stages. This method ensures that the money is used for its intended purpose, that work is completed to a satisfactory standard, and that the lender's risk is mitigated by tying fund releases to verified project progress.
Who conducts the inspections for a loan draw?
Inspections for a loan draw are typically conducted by an independent third-party inspector or an appraiser hired by the lender. This ensures an unbiased assessment of the completed work and verifies that it aligns with the approved plans and budget before funds are released to the borrower.
What is a 'holdback' in the context of a loan draw?
A holdback refers to a portion of the funds from each loan draw that the lender retains until the project is fully completed, all final inspections are passed, and all necessary documentation (like lien waivers) is submitted. This serves as an incentive for the borrower to complete the project and protects the lender from potential issues such as incomplete work or contractor liens.
How does a loan draw impact project cash flow for an investor?
Loan draws significantly impact an investor's project cash flow by requiring them to fund initial work out-of-pocket before reimbursement. Investors must carefully manage their working capital to cover expenses between draw requests. Delays in inspections or documentation can disrupt the draw schedule, leading to cash flow shortages and potential project delays if not properly anticipated and managed.