Hard Money Draw Question

[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?

[Stuart Udis]

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.