IN THIS ARTICLE
Schedule of Values
The Payment Schedule
Disbursing the Funds View all FINANCE articles
The draw schedule is a detailed payment plan for a construction project. If a bank is financing the project, the draw schedule determines when the bank will disburse funds to you and the contractor.
The goal is to make progress payments to the contractor as work is completed. You don’t want to pay for materials that have not been delivered or work that is not complete. It’s not your job to provide working capital for the contractor. (If you are an owner-builder, the draw schedule will determine when the bank releases money to you to pay for materials and subcontractors.)
Draw schedules are typically proposed by the contractor and may be further negotiated between the contractor, the bank, and yourself. If a bank is involved, they may want to use their own standardized draw schedule. But in any case, the bank’s appraiser will make sure the draw schedule is reasonable based on his knowledge of construction costs. If you are paying cash, you will need to do your own independent estimate (or hire an estimator or appraiser to review the draw schedule), or trust that the contractor’s proposed payment schedule it is reasonable.
The number of payments in the draw schedule will depend on the size of the project and the preferences of the builder or bank. A draw schedule of five to seven payments is common for a new house.
Most draw schedules link payments with milestones in the project, such as completion of the foundation and completion of the rough framing. Sometimes, the draws are more generally based on the percent complete of the total job.
In either case, the payment should be roughly equal to the value of the work completed. These line-item values have been determined by the owner or builder in their detailed estimate, and are summarized in budget breakdown called a schedule of values. This cost breakdown will also become your project budget. If you are working with a lender, contact them first to see if they have a specific format to follow.
SCHEDULE OF VALUES
To avoid conflicts over payment, it’s important that the draw schedule closely reflect the actual value of work completed. The schedule of values can be highly detailed or pretty basic, depending on the type and size of project and the financing arrangements. In either case, a good draw schedule is based on an accurate, detailed estimate, and the resulting schedule of values:
Download sample New Home Schedule of Values.
| Sample Schedule of Values for a 2000 sq. ft. Custom Home | ||
| Cost | % of total | |
| Plans and specs | $2,000 | 1 |
| Permits, fees, inspections | 4,000 | 2 |
| Impact fee | 3,000 | 1.5 |
| Clear lot, rough grade | 1,500 | 1 |
| Survey | 1,000 | 0.5 |
| Water hookup and fees | 3000 | 1.5 |
| Sewer hookup and fees | 3000 | 1.5 |
| Well, pump, hookup, and water treatment | NA | |
| Septic system and hookup | NA | |
| Excavation and backfill | 4,000 | 2 |
| Foundation and flatwork | 12,000 | 6 |
| Rough Framing | 31,000 | 15 |
| Windows | 6,000 | 3 |
| Exterior doors and hardware | 2,000 | 1 |
| Roofing | 5,000 | 2.5 |
| Siding and ext. trim | 10,000 | 5 |
| Gutters and downspouts | 1,000 | 0.5 |
| Plumbing rough-in | 9,000 | 4.5 |
| Electrical rough-in | 8,000 | 4 |
| HVAC | 8,000 | 4 |
| Insulation | 3,000 | 1.5 |
| Drywall | 10,000 | 5 |
| Stairs | 3,000 | 1.5 |
| Interior trim | 7,000 | 3.5 |
| Interior doors | 2,000 | 1 |
| Painting interior/exterior | 7,000 | 3.5 |
| Cabinets and countertops | 12,000 | 6 |
| Appliances | NA | |
| Lighting Fixtures | 2,000 | 1 |
| Plumbing Fixtures | 4,000 | 2 |
| Floor coverings: wood, tile, carpet, vinyl | 12,000 | 6 |
| Garage doors and opener | 2,000 | 1 |
| Porch, wood deck, or patio | 5,500 | 3 |
| Driveway and walkways | 6,000 | 3 |
| Landscaping | 6,000 | 3 |
| Other | 5,000 | 2.5 |
| TOTAL CONSTRUCTION COST | $200,000 | |
|
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The sample above is based on a typical, small custom home. The numbers, of course, will vary enormously, depending on a wide variety of factors, including the size and quality of the home, the materials selected, and the location. But the numbers in this sample are typical for an average new home, and will give you a sense of where the money goes, and where you may be able to cut if your house comes in over budget.
If the estimate was done by you, the owner, the numbers will represent your actual cost for materials and labor. If your contractor does the estimate, these numbers will be as much as 20% to 25% higher, accounting for the contractor’s overhead and profit.
THE PAYMENT SCHEDULE
Banks distribute money for a project in several payments as the work progresses. While procedures vary a bit from lender to lender, all follow the general principle that the bank does not want to pay for work that has not been completed. (Nor should you if you are funding the project with your own cash!)
A typical draw schedule for a new home has five to seven payments, but some may disburse money as frequently as once a week. Most draw schedules link payments to the “substantial completion” of a phase of work such as the foundation or rough framing.
Others correspond more generally to the percent of completion of the entire project, a more difficult number to track, leaving greater room for disagreement. A bank draw schedule is generally more complex than a cash job. Compare the draw schedule in Fannie Mae’s model Construction Loan Agreement to the samples below from owner-financed projects.
| Sample Draw Schedule: Small Remodeling Project (owner-financed) |
||
| Work Completed | Amount | |
| Draw 1 | Demolition | 3,000 |
| Draw 2 | Framing, wiring and plumbing rough-in, insulation. | $6,000 |
| Draw 3 | Drywall, windows, cabinets. | 6,000 |
| Draw 4 | Patch exterior, painting, flooring, fixtures, cleanup. | 5,000 |
| Sample Draw Schedule: Custom Home or Addition (owner financed) | ||
| Work Completed | Amount | |
| Draw 1 Foundation | Plans and specifications, permits, excavation, footings, foundation. | $37,500 (15%) |
| Draw 2 Rough Framing |
Wall and roof framed and sheathed. Subflooring, interior partitions. | $37,500 (15%) |
| Draw 3 Dry In | Asphalt shingle roofing, wood siding, windows, exterior doors. | $37,500 (15%) |
| Draw 4 Rough In | Rough HVAC, electrical, plumbing. Set tubs and shower. Insulation. Flatwork. | $30,000 (12%) |
| Draw 5 Trim Out | Drywall, interior doors, cabinets, countertops, interior trim, finish flooring. | $50,000 (20%) |
| Draw 6 Substantial. Completion | Exterior trim, gutters, water and sewer hookups, finish plumbing and electric, carpeting, garage doors. | $45,000 (18%) |
| Draw 7 Retainage | Substantial Completion | $12,500 (5%) |
Payment for work completed. The contractor, naturally, is in a rush to get paid for work completed and would like to be a little ahead to have some working capital. You and the bank, on the other hand, only want to pay for materials delivered and work completed. It’s not your job, or the bank’s, to provide the contractor with working capital. However, some jobs do require more money than normal upfront, for example, to for costly special-order items such as SIPs (structural insulated panels).
Simply put, the contractor is afraid of not getting paid for work completed or materials he has purchased and the owner (and bank) is afraid of paying ahead of time for work that may never be done or done incorrectly.
A good draw schedule strikes a reasonable balance between the builder’s need to get paid on time and the owner’s and bank’s need to pay only for work completed. The key is to have a payment plan that is based on an accurate budget, fair to all parties, and easy to follow. In that case, there should be few problems with payments.
Front-loading. Some builders like to front-load the payment schedule to improve their cash flow and to act as a buffer in case, for any reason, the owner withholds the final check. They may ask for a large down payment, or simply fatten the early draws to stay ahead of their expenses. Another ploy is to link payments to the beginning, not the completion, of a phase of work.
This is risky for you since many things can be started without any being completed. For example, if $20,000 is due at the start of Rough-In, it doesn’t mean that the siding has been installed even though it was paid for in the previous draw. This benefits the contractor, but can leave the owner far ahead on payments. Banks will not approve this type of payment schedule and neither should you if you are paying cash.
If you are also buying land. In this case, the first draw, including your down payment, will be used to purchase the land, including closing costs. It may also cover some the “soft costs” such as permitting and site development in the case of vacant land.
To protect homeowners, some states, such as California and Maryland limit the size of the down payment on home-improvement contracts. The limit in Maryland is one-third the contract price; in California the limit is 10% or $1,000, whichever is less.
Owner financing. If you are not borrowing money, you will still need to establish a draw schedule with your contractor so that you don’t get ahead of the work completed. It’s not your job to play banker and provide your contractor with working capital or extra spending money. However, it’s reasonable for the contractor to ask for money to cover the deposit on special-order items. If you are putting up a lot of money, it’s best to put the material orders in your name. If anything goes wrong along the way, at least you’ll own the 20 high-end windows you’ve paid for
My experience as a contractor. As a contractor, I never got “stiffed,” as in not paid the final check, but I often heard such stories from other contractors. In some cases, I’m sure the contractor should not have been paid in full because he did a lousy or incomplete job. In others, I suspect the owners withheld money for no good reason – or a little of each. However, in my experience, if the draw schedule is fair, the contractor reputable, and the owner reasonable, the payment process should go smoothly. Yet another reason to find a contractor you have confidence and trust in. Hint: He may not be the lowest bidder on the job.
DISBURSING THE FUNDS
The most common approach is to make payments contingent on substantial completion of key phases of construction, such as the foundation or rough frame. Banks send an inspector to approve each payment and charge an inspection fee of $50 to $100. If no bank is involved, you (or your construction manager) will want to stop by to confirm that the reported progress is being made.
“Substantial completion” means that the payment request if valid even if a few 2x4s are missing from an otherwise complete frame. The contractor should not request a payment before it is due, and you should not nitpick a few loose ends. An exception is the final check, which should not be released until everything is complete and correct.
Title companies. Some bankers use a title company to conduct the inspections and disperse funds. This adds more fees and delays payments, so discuss the pros and cons of this procedure with your lender, as you may be able to opt out of using a title company and handle the disbursements yourself.
Lien wavers. Assuming the inspection passes, the proper documentation is supplied, and the general contractor signs a lien waver, the funds will be wired to the builder’s account, minus the 5% to 10% held back for retainage. The bank may require other lien wavers, for example, from key subcontractors, or the largest supplier, before the last check is released. Even without a lender involved, you will want to get lien wavers from the general contractor and main suppliers, at least before cutting the final check.
Change orders. It is in the best interests of all parties to keep the work on schedule, pass all inspections, and avoid changes to the plan. Some banks will not pay for change orders, which can be a good thing as it motivates the builder to make sure nothing essential is left out of his bid. If the owners decide to add a $3,000 jetted tub or to upgrade from carpet to hardwood floors, they will have to come up with the cash out of pocket.
Final payment. Generally, progress payments are made directly from the lender to the contractor, while the final check is made jointly payable to the owner and contractor after all work is complete and the certificate of occupancy (CO) has been issued. The joint check, requiring both endorsements to cash, gives you, the owner, some leverage to get the contractor to take care of any punch list items, or other loose ends before handing over the final check.
Conflicts over payment. While most projects with a reputable builder proceed pretty smoothly, occasionally bad things happen. A contractor can skip town or go bankrupt, a sub can show up drunk or not at all, an innovative building system may not work out as planned, or the new super-duper paint specified for the project peeled off the new wood siding for some reason.
If there are significant problems at the end of the project, you should have a frank discussion with your bank and loan officer about withholding the final check until the problems are resolved. At the least you should withhold enough money to get the work corrected by another contractor if necessary. The loan officer may want to cut the final check to get paid, but the bank may not want to hold a mortgage on a property with serious flaws that lower its value – or one with possible litigation pending.
Withholding money is a powerful motivator, but will not endear you to the contractor. Whatever happens, always be civil. Explain that you fully intend to pay up as soon as the job is completed. Whatever the issue, do your best to work out an acceptable resolution with your contractor. If you cannot work things out satisfactorily with the contractor and bank, it’s probably time for a quick consult with your lawyer. Read more on dispute resolution.
See also Consthruction Loans
Nikki Aronin says
Should I Pay Extra $8,000 On First Draw?
We are re-building a house and paying cash – no bank is involved. The draw schedule shows a percentage for concrete footings, foundation, and slab at 7% of the total cost, but the builder is saying he needs additional concrete costing us $8,000 more than the schedule shows. This is just the beginning of the build Is this normal to ask for extra this early?
buildingadvisor says
Short answer: yes, this is unusual and not a good sign. It could be a harbinger of more surprise price increases to come.
The main question is whether this is a valid extra charge based on the terms of the contract, such as a change in the plans initiated by you (and resulting in a change order), or a hidden condition, such as subsurface soil conditions, or a change in material costs allowed by the contract.
Or is it simply that the contractor made an estimating error and wants you to cover the shortfall?
On a fixed-price contract, it is unprofessional to change a price or payment schedule without cause and you would have valid grounds to refuse the payment.
On a cost-plus contract, you would need to pay the extra charge if it can be documented by the contractor. However, he still owes you a valid explanation.
Hopefully, you have a detailed written contract that provides some guidance for resolving this issue. If not, you are left to negotiate a mutually acceptable agreement with the contractor. As your question implies, his early departure from the payment plan is not a good sign. Many small contractors are much better craftsman than businessmen, and this change could be a result of poor recordkeeping and a generally disorganized business.
I would suggest sitting down with the contractor and getting a very good handle on the reason for the extra charge and whether more of these are likely. If a written contract is sketchy or non-existent, and does not clearly indicate what is and is not included in the contract (the Scope of Work), and what it will cost, then I would take to time to clarify and document this now.
If you have a cost-plus contract, the final cost is not guaranteed. This can be very problematic for the homeowner. But the same logic prevails. Have him review his estimate and make sure it is sufficiently detailed and accurate. It is non-binding, but at least it puts the contractor on notice that you are paying attention. You don’t want to alienate him as you need to work as partners on your project. But you don’t want to come across as a pushover with an open checkbook either.
MB says
Contractor Asking For Extra Money To Pay Subs
Our contractor is charging a 12% fee for building our house. He has been taking his 12% out of each draw instead of waiting until the end of the construction project. Is this common/normal? The issue is that we are constantly being told he is out of money and needs more to get subcontractors paid. But this wouldn’t be the case if he was not taking out that 12% each draw. It has also caused us to be two months behind.
buildingadvisor says
There are many different payment schedules and different types of contracts. It’s unclear from your question whether this is a fixed-price contract or a cost-plus (time & materials) contract. It’s also unclear as to who is releasing the draws – you or a lender.
If you are paying the contractor a percentage fee, it sounds like you have some sort of a cost-plus contract. In that case, you are typically billed as work is completed, plus the contractor’s fee. So that part is customary.
However, if the contractor is unable to pay his subs on time under the payment schedule you have agreed to, then it is his problem, not yours. He can certainly ask you and/or the bank to modify the payment schedule, but you are not obligated to do so. Perhaps, he will have to temporarily share some of his 12% fee with his subs to keep them happy. Cash-flow management is a challenge for many small contractors, but asking the owner to finance his subs is not a professional approach.
There is always some tension between owners and contractors around payment schedules. Owners do not want to pay for work that is not completed or materials that are not delivered, while contractors do not want to finance the job (like paying subs or ordering materials) out of their pocket. Contractors want to front-load the payment schedule; owners want to pay for only what is complete – and have enough money to complete the job with another contractor, if necessary. The payment schedule is therefore a compromise between these competing interests.
Bobby Calamusa says
Can Construction Loan Draws Go Directly To Owner?
Hello,
I’m paying a contractor a fixed fee for managing and overseeing a new home build. He is working on estimates to submit for a construction loan. If I am essentially subbing out the project, but hiring a general contractor to oversee the project, can the bank draws come directly to me so I can pay the subs directly?
buildingadvisor says
In most cases, the bank draws are paid directly to the contractor, who submits a draw request after completing each phase of the work as detailed in the loan schedule. The draw request triggers an inspection and review by the bank before releasing the money. Many banks require contractors to sign lien wavers with each draw to certify that subcontractors and suppliers are being paid. In some cases, the checks are made to both the contractor and subcontractor for the same purpose.
It sounds like you are hiring a contractor to act as a construction manager. In that case, the owner is legally the contractor and is the person responsible for hiring and paying the subs. The construction manager works in an advisory role to the owner and can act as the owner’s representative, but ultimately is not responsible for work quality, scheduling, or payment of bills.
In that case, the lender may be willing to release the progress payments directly to you, the owner, but may be more comfortable working with the construction manager because of their experience with construction work and the draw process. If you can convince the lender that you can handle draw requests and pay subs and suppliers in a timely fashion, then they may be willing to release the payments to you. It’s their call.
Mitchell Fontana says
Schedule of Payments For Cost-Plus Contract
How do you handle labor productivity on a cost-plus contract. We have not yet discussed the schedule of payments and I want to keep everyone honest with regards to labor. My contractor self performs most of the work and owns most of the equipment. I was going to ask for MS projects labor schedule with detail tasks tied to the schedule of payments so we can identify deltas in the schedule (plus or minus). This plus the invoices compared to budgets should allow me to see root causes to these deltas. I feel that this will keep everyone honest. It’s a start. Can you tell me your suggestions and experiences on this. I will be closing my loan and starting permitting and excavation within the next few weeks. Thank you in advance.
buildingadvisor says
I’m not a big fan of cost-plus contracts as they place all of the risk of cost-overruns on the owner. Also, contractors have little incentive to work efficiently or minimize costs under the typical cost-plus-a-percentage approach to billing. The longer the job takes, the greater the profit. Also, precisely defining what is a direct, billable cost and what is covered by the contractor’s overhead can be challenging and subject to debate. For example, is the owner’s time spent managing the job a direct cost or overhead?
On cost-plus-a-fixed-fee contracts, the contractor has a greater incentive to get the job done quickly as his profit is capped. A guaranteed maximum price is another approach that protects the owner from runaway costs. More complex approaches split the savings if the contractor comes in under-budget, a pretty rare occurrence in my experience.
It sounds like you are trying to protect yourself from cost overruns by monitoring the work progress and billing. You don’t want to have paid out 50% of the project cost for a project that is only 25% completed. A payment schedule tied to “work completed” provides some protection if the payment schedule is reasonable. There is always a tug-of-war as the contractor generally wants to front-load the payments, while the owner does not want to pay for incomplete work or materials not yet delivered.
Most cost-plus work is billed weekly or monthly based on labor hours and invoices paid for materials and subcontractors. The amount of documentation varies a great deal depending on the type of job (for example, residential vs. commercial), but the owner has the right to review labor records and invoices. This involves a lot of detailed recordkeeping, not a strong suit for many small contractors. Also recordkeeping takes time, adding to the contractor’s overhead costs.
Comparing your payments to a detailed schedule of values, like you suggest, is a worthy goal, but I doubt if it you will get the level of precision you desire. You will have to contend with partially completed tasks using an estimated “percent complete.” On the materials side, there may be materials delivered but not yet paid for, materials stored on site but not installed, and so on.
You can guard against significant overspending early in the job, and guard against surprise costs at the end of the job, but you will have difficultly identifying the specific pluses and minuses. This type of analysis, called “job costing,” is sometimes done by contractors at the end of a job to help with the accuracy of future estimates. But doing it in real time will be challenging.
At the end of the day, cost-plus contracts require a high level of trust on the part of the owner and a high level of professionalism on the part of the contractor. The risk of cost overruns can be reduced but not eliminated. With a clear Scope of Work, based on detailed plans and written specifications, a fixed-price contract is usually preferable in my opinion.
Mitchell Fontana says
Thank you so much for your input. It is greatly appreciated. I am at a cost plus 10% with contractor. Design is fixed and I am buying all that I can directly which they will not take 10% on the materials (only labor for install).
I wanted to tie back the estimate to labor hours per task at straight time to make sure they can show progress for each task with % of completion. No cost plus contract works unless both sides trust each other.
There were no contractors in area close enough that were willing to accept a cost plus fixed fee/not to exceed/or incentive type on a custom build (plus ranged from 10-25% in some cases). They did not want the risk due to current environment with labor shortages and material prices and delivery. To mitigate the labor exposure. I have gone with a contractor whom self performs most of work (electrical and plumbing subcontracted) and owns most equipment (except for Crane rental on roof trusses). I have done background with their Banks which they have done work with, interviewed the inspectors (banks and city/county). All have no red flags and no current BBB/UCC or mechanics liens on projects. I have hedged my bet with a 3% construction to perm loan and have at least a 10% back up contingency I can use for issues.
I am living within view of my construction site to be able to check and coordinate daily if need be. Nothing ever comes good without hard work. FYI! Budget for 3300 sq fee (including garage) $685K. $207.58 sq/ft. I’ll send you a final. Should start 1st or 2nd week Dec 21.
elena says
What Are Reasonable Fees for Construction Loan?
What is a fair price for the bank to charge the constructor in a construction loan for a commercial property of 5120 sq ft? For each draw: in regard to inspection?, lien search? and title search? thanks
buildingadvisor says
I’m more familiar with residential construction loans than commercial. Also, construction loans are highly variable, as are the fees. Construction loans are short-term and risky to a lender, so the fees tend to be higher than for a mortgage. Lenders often make more money on the fees than in interest charges.
Your credit score, the size of the project, local market conditions, and the perceived risk all affect the rates. Also, some states require title updates at each disbursement, adding to the cost.
The “loan-origination fee” is often 1% or more and related to the loan interest rate. This is often negotiable, but the lower the fee, the higher the interest rate you will pay.
Total fees are typically 2-3% or more of the loan amount. As for the specific fees you mentioned, it depends in part on whether the lender is doing the inspections internally, hiring a third party, or processing all the draws through the title company. A fee of $250 to $500 per draw is not uncommon.
Lenders don’t like to talk about fees until it’s time to sign the loan documents. Some advertise “no hidden fees” such as document preparation fees and loan-commitment fees. It’s best to ask up front what all the fees are so you can do an apples-to-apples comparison between lenders. It takes some work on your end.
Read more about Construction Loans and Fees
Robert says
Is It Reasonable for Contractor To Add Finance Charge?
Is it reasonable for a roofing contractor to charge a finance charge on 3 separate payments for a roofing job? For example, if the roof costs $6,000 and the payment is $2,000 for materials ahead of time, $2,000 during work, and $2,000 due after final inspection – should there be a $600 finance charge added in?
Also – when is work considered “complete” – after they finish for the day? Or after a certain amount of time, to make sure leaks don’t happen when the next rain falls?
buildingadvisor says
If you got a fixed bid for $6,000, and made all the payments on time, then tacking on a $600 finance charge at the end of the job is very unfair and possibly illegal (unless the extra charge is specifically included in the contract).
You are only responsible for the amount stated in the contract. Changing the price is a form of “bait and switch”. Many states have laws that specifically regulate home improvement contractors and prohibit this sort of thing. You may want to contact your state’s Attorney General or Consumer Affairs Division for further information.
On the face of it, you are already financing the project by providing a $2,000 for materials at the beginning of the job. In some states, this deposit would be considered excessive to begin with. Perhaps the contracto should be paying you a finance charge.
Final payment is generally due when a project is substantially complete. On a small job like this final payment is usually not made until the work reaches “final completion”. That means all punch list items are fixed, the site is cleaned, and all work is completed. That means you may not get to wait until the next rainstorm before making the final payment.
If you have reason the believe that the new roof will leak the first time it rains, maybe you hired the wrong contractor. One option would be give the roof a good soaking with a hose, with special emphasis on valleys, skylights, chimneys, flashings, and other transition points where leaks are likely to occur. If you find a leak, get it fixed before cutting the final check.
Newbie101 says
Does Draw Schedule Pay for Architect?
Hello. Are consulting fees, for example, Architect, Mechanical Engineer, etc., including in the construction draws?
buildingadvisor says
Lending policies for construction loans vary a lot from one lender to another. Many don’t offer construction loans at all.
That said, most construction lenders will include at least some of the “soft costs” of construction, including design, engineering, and permitting, in the loan amount. When included, these are usually part of the first draw.
Since you cannot get a construction loan without a set of plans and a contractor’s bid, you may need to pay for the design fees out-of-pocket and get reimbursed from the first draw.
Just remember that the first draw is generally taken from your down payment with the lender. So one way or another, you will end up footing the bill for this phase of the work.
Linda says
Contractor Disputes Draw Amount with Bank
Do contractors sign something with the bank for the draw agreement?
Our contractor does not agree with the bank inspectors and the reduced draw amount and is threatening us.
buildingadvisor says
Ideally, the owner, bank, and builder are in agreement on the draw schedule at the outset of a project. Some lenders have the contractor sign a draw schedule that takes priority over the payment schedule in the contract. Some banks require the contractor sign a document that allows the bank to legally act as the owner during the project. Policies vary a great deal.
When the builder does not accept the bank’s proposed draw schedule, the differences need to be resolved or you will have ongoing problems. If the bank and builder cannot negotiate an agreement, you can either find a new builder or to make up the difference out of pocket.
In general, contractors want to front-load the payment schedule so they are not financing the work. Lenders and owners prefer to pay for work after it is completed. They prefer milestones based on completion of work, not the beginning of each phase.
It sounds like, in your case, the problem results from a failed inspection. Inspections, often done by third-party inspectors, provide assurance to the bank that the work is completed and meets industry standards. You need to find out the reason for the reduced draw amount and decide how to proceed.
As the owner, you always have the option of paying out of pocket to bridge the gap between the bank’s disbursements and the contractor’s requests.
However, if the contractor is “threatening” you, it sounds like things are already spinning out of control. You need to maintain a working relationship with the contractor to get the job done.
I would recommend a face-to-face meeting between you, the lender, and the contractor to iron things out. To get things back on track, you need to find out the source of the dispute and find a resolution. If that’s not possible, then it may be time to consider firing the contractor and moving on — although this is a messy and expensive process. A lawyer can help you evaluate your options.
In the meantime, I would recommend carefully documenting the job progress with any correspondence, invoices, and photos of the work. This will be very valuable if the problems persist and you need to bring in third parties – mediator, arbitrator, or the courts – to resolve the issue.
Norma says
Should First Draw on Construction Loan Pay for Land?
I am considering a residential construction project, partially funded with my funds up front (50%) through a bank with a mortgage for the balance after completion. The construction manager indicated the first draw would be almost $100k for the lot (which is part of a subdivision where he is listed as the builder). Does this sound appropriate? It is supposed to be a one-closing transaction. I’m beginning to question the entire transaction.
buildingadvisor says
When buying a lot and house with a single construction loan, the first draw typically does pay for the land. Whether the land is from a third-party seller, or from the builder, the bank will treat the land as collateral during the construction phase. The lender will either hold the title to the land or hold a first lien on the land to secure the loan.
Construction loans are considered risky to banks, so they generally require higher down payments, or use the land or other real estate holdings as collateral to cover their losses in the event of a default. Defaults are unlikely, but can happen for a variety of reasons: bankruptcy by you or the builder, costs spiraling out of control, environmental hazards are discovered, etc.
If the project runs into trouble, through no fault of your own, the bank will usually work with you to get the job completed. They really don’t want to be in the business of owning and selling a lot with a half-built home. Depending on the issue, they may restructure the loan or work with you to find another builder.
So your risk of losing your initial investment is pretty small. However, since you are putting so much cash into the project, you have other options. You could buy the lot with your cash and take possession of it. Then use the lot as collateral on the construction loan.
You could also consider a two-time-close construction loan. Make the minimum down payment required on the construction loan, and then put in your additional cash at the time of the permanent mortgage.
Finally, ask if the developer will sell you the finished home using a conventional mortgage. This is a common scenario with larger builder/developers selling land and lot packages. You sign a contract, make an earnest money deposit, and then start your mortgage loan when you close on the completed house. In this case, the developer is financing the construction of the house and you save on the cost and complexity of a construction loan.
Best of luck!
buildingadvisor says
Not all contractors ask for a deposit and a request for a large deposit can be a red flag. When a deposit is paid, it should definitely be applied toward the first payment. At the end of the job, you want to owe the contractor a little money, not the other way around. That provides some leverage to get any loose ends tied up and any problems corrected. Never release the final check until all work is completed and approved by you.
How much to hold back at the end of the job depends on the size of the job and amount of work to be completed. You can read more about procedures for releasing the final check.
Best of luck with your project!
Kirtan Kapadia says
Why Does Bank Require Its Own Draw Schedule?
Why does the bank need a draw schedule when the architect will manage the project and will certify the payments?
buildingadvisor says
The bank is trying to protect its own interest in the loan by not paying out more money than completed work. So naturally, they are going to trust their own appraisers rather than your architect. Some architects are very good at overseeing the financial side of a project; others are not. Having the bank oversee the draws helps protect you as well if you need to switch contractors, mid-project, for any reason. Best of luck with your new home!
brenda says
Invoice After the Final Signoff?
Is the contractor legally required to give you the final invoice before the final sign off. That is, can the builder give you an invoice after you have signed off on the project?
buildingadvisor says
The final payment on a construction contract is often a stressful time when any conflicts, misunderstandings, or dissatisfactions over the course of the job come to a head. Final payment can be handled in different ways, but typically, the owner makes the final large payment, based on the draw schedule, upon “substantial completion.”
Whether you have a fixed-price or cost-plus contract, it is customary for the contractor to apply for final payment, and for the owner to do a walk-through inspection before “signing off” (accepting) the work and releasing the final check. At that point, the owner may withhold a reasonable amount to cover the cost of any punch list items.
It sounds you were surprised by a large invoice after you thought the project was fully paid for. Whether or not the invoice is valid would depend on the specific language of your contract and state law. If the invoice was related to change orders or allowances, these should have been agreed to in writing when the work was done – not presented as a last-minute surprise invoice.
At a minimum, the contractor is disorganized in his billing procedures and did a poor job of communicating about project costs and overruns. At worst, he wanted your signature accepting the work, before hitting you with a big bill at the end.
If you feel that this was an intentional act to get paid an unfair amount, I’d suggest you have a brief conversation with a construction lawyer about your legal options.
T.G. Obenchain says
Can I Hire Someone To Manage Draws and Lien Releases?
I am financing my own home construction via a general contractor. I’d as soon not deal with the liens and pay for the draws myself. Can one hire a company to do this even though he is not financing through a bank? Would it be a title company, a retired contractor or the like?
buildingadvisor says
If I understand your question, you are hiring a general contractor and paying for the work with your own cash.
You will still want to get lien releases from the GC and subs to prevent their suppliers and other creditors from placing a lien against your property if they are not paid. This should be written into your contract as a condition of payment.
You can see sample language for lien releases in our model construction contract (Section E. Final Payment).
It’s the contractor’s job to provide the releases so you would not need a title company or retired contractor to help out. However, you might want some help with inspecting the work prior to releasing each payment. If you want someone to evaluate the quality of the work in addition to its completeness, then a contractor (acting here as a construction manager) would be a better bet than a title company. The construction manager could be a retired or active contractor, architect, or any building professional willing to work in that limited role.
Best of luck with your project.
A Heslop says
When Should Draws Be Released To Contractor?
When should building contractors get paid? Before and during as progress payments for materials and labour or at the end?
buildingadvisor says
The answer to your question depends on the size of the job. For a small job – say a few hundred dollars – payment is often a single lump-sum at the end, based either on a fixed bid or materials and labor.
On a larger job, contractors often want a down payment, one or more “progress payments” over the course of the job, and a final check at the end.
Sometimes a down payment is needed to pay for special order materials. Otherwise, I would not make a substantial down payment and only pay for work completed. The general rule with progress payments is that you only want to pay for work completed so the contractor has an incentive to complete the job.
You also want to be holding enough money to hire someone else to complete the job in the event that the original contractor does not due so – or does a poor job and you need to hire someone else to fix and complete the job.
Read more about Down Payments and when to pay The Final Check.
Archie says
Can Construction Loan Include Land Cost?
Can a bank give a mortgage loan to a builder on both the land and the building to be constructed.
For example, could I get a loan for 100,000 of which $20,000 is for the land and $80,000 for the building to be constructed?
buildingadvisor says
Many banks that make construction loans can structure a loan to cover both the land purchase and building costs. However, the bank will require a larger down payment since they cannot hold the land as collateral.
The bottom line is that you need to check with a loan officer at your bank. Every bank has their own recipe for construction loans and they are a lot more variable than standard home mortgages.