Hard Money Draw Question
Investor · Phoenix, AZ · Member since 2017 · 108 posts · 30 votes
Hard Money Draw Question
Most Popular Reply
Stuart UdisPro Member
Attorney · Philadelphia · Member since 2018 · 2k+ posts · 3k+ votesThe budget that's submitted to the lender should have a contingency line item. You can usually shift cost figures around if the scope was completed for less than the initial budget indicated. By way of example if your budget included $20,000 for framing and you only spent $15,000, the lender should allow for the $5,000 that was not spent to be shifted elsewhere in the budget. As a general rule of thumb, its best to overstate your contingencies in your construction budget. This is particularly the case when the contingency is baked into the loan. A lot of borrowers are too focused on their out of pocket cash at time of the acquisition or loan funding and opt to keep their budgets lean for the sake of reducing their cash requirement on day 1. This is because most construction lenders will look at the total project cost and require 20%-25% to be funded by the borrower. Therefore, the bigger the budget, the more cash needed up front. I am a strong proponent for understanding the max LTV and funding parameters of the lenders and as long as the LTV falls within the lender guidelines, add as much contingency funds (and interest reserve) as you are able. Usually an additional $5,000 of cash up front translates to an additional $15,000 in contingent funds. There's nothing worse than being involved in a project that is incorrectly funded. Shortfalls in funding kill deals, even if purchased correctly. Being properly funded goes along way towards ensuring your projects smoothly get to the finish line.
23 Replies
- Investor · Tampa, FL · Member since 2015 · 63 posts · 59 votes2y
I haven't worked with hard money lenders, only private, so haven't run into these issues. Are you typically maxed out on the LTV guidelines or do you have additional capacity but it's just one outlined in the initial scope? Could you include an unforeseen line item? When I run rehab estimates, I typically include 10% of the rehab budget in an "other" line item. Like I said, I e just been using private money so as long as I provide receipts, draws haven't been an issue but I haven't had to go over the max before. Another approach is to inflate your numbers a bit to give some more wiggle room. I would think that if they approached a $x rehab budget, they wouldn't care if some items came in under and some weren't in the original scope so long as you don't go over $x.
- Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes2y
@Ron Hollingsworth
As a lender we see this often and it out the onus on the borrower to fund those out of pocket.
Basically as a lender we are giving you X dollars to complete the job and if you spend too much upfront then you will end up being short on the back end and have an unfinished project where we get stuck with it.
The way to resolve this is to do better due diligence upfront to understand the costs AND make sure you have a contingency
So if construction is $100,000 you should have 20% of your own costs in reserve to make up for these.
It’s similar to buying a normal house and doing an inspection, after you agreed to price and financing everything after that is on you
7e investments53 Reviews - Member since 2023 · 158 posts · 96 votes2y
Addressing the issue of changing the scope of work (SOW) during a flip project financed by hard money loans involves several specific steps:
Detailed Initial Assessment: Before finalizing your SOW, conduct a thorough inspection of the property. This might mean investing more time or bringing in various specialists (like structural engineers, plumbers, electricians) to identify potential hidden problems before submitting the initial SOW. This approach can minimize surprises once work begins.
Flexible SOW with Contingencies: When drafting your SOW, include potential contingencies for common issues that might arise during the renovation. This way, you have pre-approval for certain types of additional work and won’t need to renegotiate the SOW for every change.
Regular Communication with the Lender: Establish a clear line of communication with your lender. When unexpected issues arise, update them immediately. This might involve submitting a revised SOW or providing additional documentation to justify the changes and additional costs.
Documentation and Evidence: Document every step of the renovation, especially when unexpected issues arise. Take photos, keep receipts, and maintain detailed records. This evidence can be crucial when negotiating additional funding with your lender.
Scheduled Inspections and Progress Reports: Coordinate with your lender’s inspector to schedule regular inspections. During these inspections, present your documented changes and explain why they were necessary. Regular updates can keep the lender informed and more receptive to approving additional funds.
Negotiate a Flexible Draw Schedule: When negotiating the loan terms, try to include a more flexible draw schedule. This could involve more frequent draws or draws based on milestones rather than a fixed schedule, allowing for more adaptability to changes in the project.
Seek Legal or Financial Advice: Consult with a legal or financial professional who specializes in real estate investment. They can provide advice on negotiating terms with hard money lenders and might suggest strategies to better protect your interests in future deals.
- Investor · Phoenix, AZ · Member since 2017 · 108 posts · 30 votes2y
Quote from @John McDonald:
Addressing the issue of changing the scope of work (SOW) during a flip project financed by hard money loans involves several specific steps:
Detailed Initial Assessment: Before finalizing your SOW, conduct a thorough inspection of the property. This might mean investing more time or bringing in various specialists (like structural engineers, plumbers, electricians) to identify potential hidden problems before submitting the initial SOW. This approach can minimize surprises once work begins.
Flexible SOW with Contingencies: When drafting your SOW, include potential contingencies for common issues that might arise during the renovation. This way, you have pre-approval for certain types of additional work and won’t need to renegotiate the SOW for every change.
Regular Communication with the Lender: Establish a clear line of communication with your lender. When unexpected issues arise, update them immediately. This might involve submitting a revised SOW or providing additional documentation to justify the changes and additional costs.
Documentation and Evidence: Document every step of the renovation, especially when unexpected issues arise. Take photos, keep receipts, and maintain detailed records. This evidence can be crucial when negotiating additional funding with your lender.
Scheduled Inspections and Progress Reports: Coordinate with your lender’s inspector to schedule regular inspections. During these inspections, present your documented changes and explain why they were necessary. Regular updates can keep the lender informed and more receptive to approving additional funds.
Negotiate a Flexible Draw Schedule: When negotiating the loan terms, try to include a more flexible draw schedule. This could involve more frequent draws or draws based on milestones rather than a fixed schedule, allowing for more adaptability to changes in the project.
Seek Legal or Financial Advice: Consult with a legal or financial professional who specializes in real estate investment. They can provide advice on negotiating terms with hard money lenders and might suggest strategies to better protect your interests in future deals.
Wow, sounds like a ChatGBT response.
- Member since 2023 · 158 posts · 96 votes2y
Hi Ron, I use chatGPT from time to time to clean up my content and check spelling and grammer. The content is written by me and checked by various tools.
Cheers,
- Investor · Tampa, FL · Member since 2019 · 1k+ posts · 1k+ votes2y
Quote from @Ron Hollingsworth:
So I've done a few flips using hard money and I'm running into the issue of them sending out their inspector to verify work, however between the time that I sent the lender the SOW (while in escrow) and the time we actually start work, the scope changes. Usually once we start the project, we learn of new or additional repairs that have to be done. We spend the time and money to address these "new" issues, however the lender/inspector have not been taking these repairs into consideration when approving the next draw. So, the draw is less than it needs to be putting me in a situation where I need to come in with additional cash outside of what I have budgeted for the project. This screws up other projects or my personal finances. Can anyone share with me what I could do differently to circumvent this issue?
Hey @Ron Hollingsworth,
The way I dealt with that, back when I was flipping properties, was by increasing my rehab budget to include an additional 10-15% for miscellaneous expenses. You can request either a portion or the full amount of that in any of the draws.
- 2yErik EstradaBusiness MemberLender · Member since 2022 · 6k+ posts · 1k+ votes
Quote from @Ron Hollingsworth:
Quote from @John McDonald:
Addressing the issue of changing the scope of work (SOW) during a flip project financed by hard money loans involves several specific steps:
Detailed Initial Assessment: Before finalizing your SOW, conduct a thorough inspection of the property. This might mean investing more time or bringing in various specialists (like structural engineers, plumbers, electricians) to identify potential hidden problems before submitting the initial SOW. This approach can minimize surprises once work begins.
Flexible SOW with Contingencies: When drafting your SOW, include potential contingencies for common issues that might arise during the renovation. This way, you have pre-approval for certain types of additional work and won’t need to renegotiate the SOW for every change.
Regular Communication with the Lender: Establish a clear line of communication with your lender. When unexpected issues arise, update them immediately. This might involve submitting a revised SOW or providing additional documentation to justify the changes and additional costs.
Documentation and Evidence: Document every step of the renovation, especially when unexpected issues arise. Take photos, keep receipts, and maintain detailed records. This evidence can be crucial when negotiating additional funding with your lender.
Scheduled Inspections and Progress Reports: Coordinate with your lender’s inspector to schedule regular inspections. During these inspections, present your documented changes and explain why they were necessary. Regular updates can keep the lender informed and more receptive to approving additional funds.
Negotiate a Flexible Draw Schedule: When negotiating the loan terms, try to include a more flexible draw schedule. This could involve more frequent draws or draws based on milestones rather than a fixed schedule, allowing for more adaptability to changes in the project.
Seek Legal or Financial Advice: Consult with a legal or financial professional who specializes in real estate investment. They can provide advice on negotiating terms with hard money lenders and might suggest strategies to better protect your interests in future deals.
Wow, sounds like a ChatGBT response.
Hahaha
LuxePrivate Investments LLC 572 Reviews - 2yMatthew CrivelliBusiness MemberLender · MA · Member since 2021 · 1k+ posts · 1k+ votesLike others have said, a hard money lender will never give additional rehab money on top of what is agreed upon when you signed for the loan. You may be able to move funds from one line item to another, or add a new line item and take money from one that is listed but you will never get more than the agreed upon amount.
Quote from @Ron Hollingsworth:
So I've done a few flips using hard money and I'm running into the issue of them sending out their inspector to verify work, however between the time that I sent the lender the SOW (while in escrow) and the time we actually start work, the scope changes. Usually once we start the project, we learn of new or additional repairs that have to be done. We spend the time and money to address these "new" issues, however the lender/inspector have not been taking these repairs into consideration when approving the next draw. So, the draw is less than it needs to be putting me in a situation where I need to come in with additional cash outside of what I have budgeted for the project. This screws up other projects or my personal finances. Can anyone share with me what I could do differently to circumvent this issue?
Freedom Capital Funding, LLC523 Reviews @Ron Hollingsworth i understand your pain and headaches with hard money draws. The inspectors ( And the landlords a lot of the time) are having a hard time!
I slove it to by funding based on CC that way I stopped taking construction draws and no need the have money in my bank. I paid the card once I sold my flip.
- Investor · Phoenix, AZ · Member since 2017 · 108 posts · 30 votes2yI don’t think I can get a credit card at $80,000
Quote from @Ron Hollingsworth:
I don’t think I can get a credit card at $80,000There are ways to get it, would be happy to explain let's connect
- Rental Property Investor · New Braunfels, TX · Member since 2022 · 409 posts · 408 votes2yWhy not explain it to all of us instead of going private? That's way we can all learn and grow together.
Quote from @Ben Aaron:
- Specialist · NJ · Member since 2022 · 1k+ posts · 656 votes2y
The only way around unforseen work is to have a contingency in your budget. If you do not have a contingency you are screwed cause once a loan closes the rehab budget will not get reopened.
So if you knock a wall down and behind it you find some old knob and tube wiring, but you didn't budget for anything electrical nor do you have a contingency then you are coming out of pocket.
- Investor · Phoenix, AZ · Member since 2017 · 108 posts · 30 votes2y
my hard money lender said that if the expense/repair is not on the SOW that I submitted to them before funding the loan, then those funds are not allotted.
- Specialist · NJ · Member since 2022 · 1k+ posts · 656 votes2y
That's true for every bridge loan lender I've worked with. But if there was a 10% contingency then you could get a draw and write the work up as the contingency.
- Investor · Phoenix, AZ · Member since 2017 · 108 posts · 30 votes2y
I asked about that. that was a no for them
- Specialist · NJ · Member since 2022 · 1k+ posts · 656 votes2y
No on Contingency? That's a new one.
- 2yBill J FayPro MemberLender · San Diego · Member since 2023 · 216 posts · 209 votes
Most lender's submit draws of reimbursement of work completed on the scope of work. Having a change order section is always smart to account for items not on your scope that pop up during construction. Ask your lender if they allow photo submission instead of a physical inspection as well.
Quote from @Account Closed:
Why not explain it to all of us instead of going private? That's way we can all learn and grow together.Quote from @Ben Aaron:
At the beginning of my journey, as a real estate investor, I was struggling with the construction cost and felt I was always tied to the budget, and together with holding costs and my life expenses I felt Iam was always tied to the budget.
As time went by we learned how to use CC the right way to leverage our investments and increase our ROI, Then started helping other investors secure capital in 0% interest for 12 months.
Not to be snarky, but sounds like you need to start with a more "robust" SOW, have more reserves, "over estimate" (these are flips after all, right?), or take on smaller / less riskier jobs. Yeah, its a problem if you want to draw out more money, but its easier if you draw less...
In my limited experience so far on this, the burden is on you for the project. Its the lender's/inspector's job to keep adjusting to your project's situation.
Maybe try private lenders that potentially you can work with them to keep adjusting your budget.
Good luck.
- Investor · Tampa, FL · Member since 2015 · 63 posts · 59 votes2y
Another thing to keep in mind, there are predatory lenders out there. Obviously I have no idea who your lender is or if they are predatory but I know there are lenders that take advantage of investors. Their goal is to take over the property and flip it themselves. There’s usually way more profit in that - plus they get to keep your down payment - than there is in lending money. Most lenders are not doing this but there are some out there that do.
For future projects, I would look for a different lender and ask them how they handle contingencies before doing the loan.
- 2yStuart UdisPro MemberAttorney · Philadelphia · Member since 2018 · 2k+ posts · 3k+ votes
The budget that's submitted to the lender should have a contingency line item. You can usually shift cost figures around if the scope was completed for less than the initial budget indicated. By way of example if your budget included $20,000 for framing and you only spent $15,000, the lender should allow for the $5,000 that was not spent to be shifted elsewhere in the budget. As a general rule of thumb, its best to overstate your contingencies in your construction budget. This is particularly the case when the contingency is baked into the loan. A lot of borrowers are too focused on their out of pocket cash at time of the acquisition or loan funding and opt to keep their budgets lean for the sake of reducing their cash requirement on day 1. This is because most construction lenders will look at the total project cost and require 20%-25% to be funded by the borrower. Therefore, the bigger the budget, the more cash needed up front. I am a strong proponent for understanding the max LTV and funding parameters of the lenders and as long as the LTV falls within the lender guidelines, add as much contingency funds (and interest reserve) as you are able. Usually an additional $5,000 of cash up front translates to an additional $15,000 in contingent funds. There's nothing worse than being involved in a project that is incorrectly funded. Shortfalls in funding kill deals, even if purchased correctly. Being properly funded goes along way towards ensuring your projects smoothly get to the finish line.
- Investor · Bucks County · Member since 2023 · 196 posts · 157 votes2y
@Stuart Udis this is awesome insight! I definitely fall into the category of people who underwrite out deals only to see where my cash is and then make modifications to my spreadsheets to reduce my cash needs. Seems like I would likely fall for the trap of being too shortsighted with how I fund my deals. Great post and knowledge shared here.
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