Remodeling (Construction)Loan, Draws, and Who Pays

12 years ago

I hope someone can offer some guidance as to what is usually done in a similar case as we are going through now. I'll try to be brief. :)

We are taking out a construction loan with a local bank to remodel our existing, older home. There are 4 projects: remodel kitchen, enclose attached screened porch, add master bath to an existing upstairs room, and remodel an existing bath. Our contractor, who has been recommended by various people, is asking that we provide some money up front to start on the porch remodel, as well as provide money to order the kitchen cabs and windows. When I asked him about his experience working with bank loans, he said he recently came off of a job where the homeowners were working with a bank....the 1st draw was taken BEFORE he did any work ...it was used to cover materials he needed to order for the job.

The bank we were working with previously (but left because their closing costs were extremely high) had said we could take the 1st draw this way, but our current bank is not giving us that impression.

While we are awaiting an additional talk with the loan officer to clarify, has anyone gone through a remodel with type of loan? Is this normally how it's done? How did the draws work and did the bank allow you to draw funds before work was started to order things?

Thanks in advance!

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Comments (6)

brickeyee
12 years ago
He does not have enough credit to order materials?

That is a red flag.

A VERY LARGE red flag.
EMC2011
12 years ago
i am considering doing an addition with a friend of mine who is also a contractor. we've used him many times in the past but not for something as big as this. we have given him checks (smaller amnts of course) to start projects...and we trust him...my question is, since the homeowners are paying for the renovation anyway, why does it matter if the contractor has enough credit to front some of the costs and get started? is it that if he has bad credit, that reflects negatively on his business etc etc?
thank you
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Some other important questions to ask ..... Is there a penalty for paying MORE than the minimum scheduled payment? Can paying more than the minimum lower your total long-term costs? How fast are you allowed to pay the amount back without penalties? Getting double what you were looking for would be nice, as that would initially make your payments worry free (since you have twice what you need, just leave a ton of it in the bank) and it also makes for a good safety net in case of minor or possibly major cost overruns ... (wife suddenly decides that she wants to splurge on a nice hardwood floor, which is a good idea in the building stages since it's hard to do it later.... or perhaps you decided to upgrade the siding or fencing or put in a pool in the back yard, ect ...) Even so, being able to make larger payments or extra payments helps to knock down the principle of the loan, so that your interest payments are lowered. The problem for the bank is, that if the interest payments get lowered, they get a LOT less money, so some of them arrange for penalties that you'ld have to pay for making early or extra payments.
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Most home remodels that are being done are with cash or HELOC's. I don't know of anyone in the past 18 months who has gotten a home remodel loan. Banks have gotten way too bit from "house flippers" who thought they could turn a profit by cheaply putting lipstick on pigs. Most will do HELOC's because the amount is smaller and secured by the equity in the home. A true home remodel loan will require extensive vetting by the bank and appraisers over the plans to be able to try and verify the value after the remodel as well as the reputation of the contractors involved so as to be sure of the completion of the project. It's part voodoo and part neighborhood value. And you should NOT put the cart before the horse on this by fronting any materials before the loan is approved. Because it may not be. However, once the loan is approved, you should pay out of pocket to get it started if need be. You should always have a safety cushion for those type of expenditures that the bank is hurry up and wait on. And at least a 20% cash cushion for overages. You will need that, and maybe more on older homes. Plus, the bank will have a difficult time approving a loan unless you can prove you really don't need a loan and actually have the cash or home equity to do the project outright.
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Yes to your own RE attorney. Yes to a methodology of lien release tracking. Yes to setting up a construction draw schedule even if you don't have a loan. Your builder should know when he needs draws and design a schedule for you. Planning is everything. Know what you want and stick to it. Strangely enough, once the foundation is dug, a lot of risk diminishes. If there are no rocks or water, your foundation costs drop off. Shop around for other lenders. You only need a construction loan. Not a construction to perm. They are different. It's good to have a line of credit in your back pocket when building. I suggest you explore a home equity line of credit on your current home. If you need it, you have it. If you don't use it, you were prepared. Lenders will love you. They love to lend to people who don't need the money. And, they love lending to people who already own the land. Expect and prepare for cost overruns. Construction lending is high risk and you are lowest level of risk of a high risk endeavor. Make the lenders compete for your business.
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juliekcmo
12 years ago
EMC, It is a precarious situation to be in. You are literally giving him a blank check.

Many contractors do multiple projects at a time. If he does not have lines of credit at various suppliers, then it is entirely possible that the money he receives from your 1st, or 2nd, or 3rd draw may be used to finish up the final items on another job, leaving yours incomplete and your money gone.

Also, if someone has had a lowering of their credit status by their suppliers form credit to COD, that could mean that they will use the money from you to pay off their bill at the supplier.

In addition, if they are in this as a profession (as opposed to a weekender or on the side guy), it is a bad sign, as brickeye said, if they are not successful enough in running their business to have lines of credit established. Because it means they have no reserves, and if something goes wrong, they may cut corners or walk away from the incomplete job.
motherof3sons
12 years ago
Echo - Brickeyee and Juliekcmo.
kaismom
12 years ago
Construction business is running a small company. All businesses need to have a line of credit to get them through the billing cycles.

I think there are two issues: available line of credit and a deposit required before the beginning of the project.

Construction companies (almost all companies doing custom work) ask for a deposit (earnest money, good faith money, whatever you call it) before the construction (or custom work) begins. This is my experience working with multiple companies in the past few years. It's typically 5 to 10% of the job in construction. Some ask for 25% or more before the work begins (ie custom cabinet companies, custom countertops etc.)

Is your guy asking for a deposit? If I was running a business, I would not spend my money without a guarantee that the customer is invested in the project. Unless the customer puts down a deposit, the customer can walk away from the contract without any monetary penalty. This is not a good place for the business to be in before the business starts to spend its money. I would absolutely ask for a deposit from my customer.

Maybe he gave you too much information regarding how he spends the deposit... That is entirely different territory of issues. Does the business have enough line of credit to get through the project?

BTW, on larger projects we did, we paid every two to four weeks. The companies generally need to be paid often enough to make their cash flow happen. Again, you, the bank and the construction company all need to be on the same page about this.
hlove
Original Author
12 years ago
I almost forgot I posted in this forum since I cross-posted...

Thank you for the responses. We will be giving a deposit (4%) to our contractor and are working something out with the bank to directly pay the suppliers from where I sourced the larger ticket items, i.e. cabs/windows.

Remodeling (Construction)Loan, Draws, and Who Pays

Comments (6)

brickeyee

EMC2011

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juliekcmo

motherof3sons

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Remodeling (Construction)Loan, Draws, and Who Pays

Comments (6)

brickeyee

EMC2011

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juliekcmo

motherof3sons

kaismom

hloveOriginal Author

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hlove
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