All bank construction loans disburse money subsequent to the work being done, and interest is charged just on the amount disbursed. Some private money construction loans charge interest on the entire loan amount from the date of funding, but banks can’t do that. In the past, there were some construction lenders who would impose a draw system on the borrowers and the builder. They would say, for example, we have a seven draw system, and here it is. Each stage like grading and foundation, or framing, had a percentage associated with it. This method was too rigid, and is generally not used today.
The amount of each draw is based on the specific cost breakdown for that particular build. The builder completes a portion of the build and requests a draw. The bank sends out an inspector (usually not a bank employee but someone from their third party fund control vendor). The inspector confirms that certain line items are done, although they are not typically inspecting the quality of the work. Draws are then made based on the amounts on the cost breakdown associated with the items that had been completed.
Start up draws for soft costs are allowed either as a percentage (usually not more than 5% of the total contract amount) or for specific soft cost amounts in the cost breakdown “Soft costs” can include permits, school fees, and unpaid architectural fees, for example. Retainage, a method affecting draws wherein 10% of the draw amount is retained until certificate of occupancy, no longer seem to be a part of construction lending. If the deal is structured such that the lot is free and clear, and the borrower is still bringing more money into the deal, that money would be put into an FDIC insured account at close of escrow, and that would be the first money disbursed as work is done.
Draws can be made to the builder directly, or in some cases, to a joint account the borrower and builder have set up for the build. Draws are generally not made just to the borrower. If the builder is not a corporation, they will get a 1099 at year’s end for the contract amount. No 1099s to corporations.