When originators fund construction loans there is a reserve funds held by the lender in a trust account or in escrow.
These excess funds are used to complete the project based on the approved budget that was reviewed during the project feasibility phase of the project. Funds control is really where things can go wrong during the entire process.
Funds control involves simple math! Start with the total held, the budget and the borrower and contractor ask for funds based on the percent complete of each line item requested. The items that need to be reviewed are the budget (making sure line items are not changed or funds moved), the inspection (it is a snap shot of the specific day and time with photos) and you must determine if the photos support the request. Photos and a Budget are NOT fund control. Many people skip the critical steps; Collecting Invoices and Conditional/Unconditional lien releases. If your inspection does not have a photo you are looking for you need to confirm with an invoice or lien release from the subcontractor ( a lien release from the general is not acceptable if subs are being used because they still have lien rights even if you have a lien release from the general). Many lenders are very loose with the collection of docs if they manage the process themselves since every state and some counties have specific doc requirements and using a doc from your current state for another may make you feel good but will not hold up in court.
You have to make the credit decision, where am I comfortable with the risk of the contractor? Is it a $30,000 paint and carpet rehab? Is it $100,000 rehab with concrete, electrical, roof, plumbing? Trades always work on “heavy rehabs” and they usually have permits and general contractors generally never self-perform these items. If you verify your contractors’ qualifications, perform a feasibility, use fund control and perform an inspection the risk of projects getting off the rails is minimized because you are able to identify issues earlier than the closing table.
About the Author, and CFSI
Brian Mingham is the founder and CEO of CFSI Loan Management, a Los Angeles based company that works with lenders to mitigate the risks associated with construction loans. CFSI oversees the entire process, from contractor review, to project feasibility reviews, fund control, and draw inspections. Through this process, CSFI helps ensure that a construction project is completed on time, on budget, free of mechanic’s liens, and ready for permanent financing.
Lending on construction projects include inherit risk. CFSI Loan Management provides lenders with a resource to reduce this risk, without the expense of creating an internal construction operation.