As a beneficiary of a loan construction, you receive money from your lender via two types of reimbursement system.
The first one is the voucher system, whereas the second option is through the draw reimbursement system. The former is more rigorous and enables banks to keep a tighter control on their funds, whereas the latter is said to be more lenient. The article will try to define and present the features of the draw reimbursement system so that the reader gains a better insight into how construction lending functions.
The disbursement process which makes the subject of the present article places the main accounting responsibility on you and your contractor. Meanwhile, the bank establishes the loan amount based on the borrower’s original project line-item cost breakdown, allowing him to ask for repayments on a designated schedule after the work is completed. Thus, in terms of timeline, some banks offer four to seven draws (money payouts), depending on the completion of certain milestones such as foundation and framing, while others reimburse the borrower on a monthly basis, collecting partial payment for work and material items that haven’t been fully completed.
When a bank uses the draw reimbursement system, it wires the funds from an LIP account to any accounts the borrower wants. This is one of the features that differ from the case of the voucher system, where the project owner takes money out from a single permanent account.
As earlier said, the draw reimbursement system is considered somehow simpler and more convenient than its alternative, the voucher system. However, besides boasting a series of advantages, the disbursement has its shortcomings as well. Let us examine each of the two sides.
ADVANTAGES OF THE DRAW REIMBURSEMENT SYSTEM
- It requires less work and fewer efforts than the voucher system – although bank inspectors are still part of the “program”, the lender no longer requires subs and contractors to sign off at every disbursement. Instead, it is checked whether the property is free of any liens at the time of the payout.
- It is easier to use – more and more banks allow the borrowers to request draws electronically through the Internet, which speeds up the process and offers greater convenience.
DISADVANTAGES OF THE DRAW REIMBURSEMENT SYSTEM
- Banks scrutinize more – since they are more permissive about the paperwork that proves the project is heading in the right direction, the lenders compensate by looking closer at issues of your contractor’s credit and your own available cash.
- It might require some additional “tests” in order to be approved – being given that the draw reimbursement system pays only after the work is completed, you and your contractor might be forced to lay out money first before you get repaid. It might be necessary to show that you have more cash on hand before getting the approval.
Once again, the loan amount that is going to be disbursed for your custom house building expenditures is settled based on your cost breakdown. Each section of work and materials (such as rough framing or permits) that are registered in this sort of inventory are called line items. The bank will comply with your money requests relating the payments to every one of these items, which are classified into hard and soft costs. You need to understand which expenses are which because the lender disburses them differently.
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Soft-Cost Reimbursement System
Soft or offsite costs refer to expenditures which are not directly related to the labor or materials in one’s project, but are generated by architecture, permits, engineering, and school fees. Usually, they have to be covered before the construction loan is in place, thus being the fastest funds to be paid back from the bank. However, since these line items don’t lend themselves to inspection, you have to provide specific accounting and a lot of paperwork consisting of copies of paid receipts. Only the proven ones are compensated within 24 to 48 hours.
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Hard-Cost Reimbursement System
Referring to the labor and materials associated with the foundation, framing, finish, and complete building of your project, hard costs represent the “core” of your construction funds. The borrower can draw upon them on an item-by-item basis, progressing as each appropriate section is completed.
Whenever you solicit money, you have to submit a form that states the extent to which each of the construction tasks or jobs has been done. Reflecting both the money paid and the money requested, the cost breakdown enables you and the lender to keep track of the percentage of total available funds left to draw on each line item. Before the bank releases the cash, an inspector is sent to the property to see whether the request is justified. If the agent agrees with you, he wires the bank, which in turn sends you the necessary funds. If not, you and the lender have to discuss the situation in order to find a middle ground.
What the borrower should keep in mind relative to his money solicitations is that they have to be as realistic as possible and in conformity with the build’s level of completion. For example, you cannot demand for 60 percent of the funds when you have completed only 50 percent of the house. The sooner you finish a certain line item, the sooner you receive the invested money via the reimbursement system.