U.S. Markets close in 1 hr 57 mins

Bankrate glossary: Draw

Glossary

A draw is a payment taken from construction loan proceeds made to material suppliers, contractors and subcontractors. Each lending institution has different requirements for requesting a draw.

For instance, some lenders allow the borrower to ask for draws online, while others require documents and regular inspections. These requirements help ensure that the proceeds of the loan actually are used to keep construction moving forward.

Lenders charge borrowers interest on the amount borrowed at any point in time.

How does a draw work?

In the some countries including the U.S., instead of paying every month while the construction is going on, almost all construction loans have extra funds that are withdrawn immediately and deposited in a locked account called an "interest reserve."

Since monthly payments are taken each month from the account, borrowers do not have to use their personal funds until the project is completed.

Lenders issuing construction loans do not always disburse the entire amount to the borrowers on the date that construction starts or at the time of the loan closing.

Draws usually begin upon completion of a pre-designated stage, such as building under roof or pouring of the foundation. It also may occur periodically, typically once a month for the specified term, followed by a "final draw." But, certain measures should be taken to lessen the risk of loss and lawsuit.

Draw request requirements

Once a designated stage of work is completed at a time specified in the loan contract, the contractor typically submits a draw request to the lending institution for verification and approval.

The submission process causes a flurry of activity, partially because the process of approval is tedious and the contractor needs the request to be approved quickly to have funds necessary for the timely payment of subcontractors.

Borrowers will have to submit request forms supplied by the lenders to initiate the draw process.

In the U.S., the G-702 (the contractor's Application and Certificate for Payment) and the G-703 (the Continuation Sheet) forms from the American Institute of Architects (AIA) are typically used.

Lenders use the information written in these forms to check what work should have been completed and by whom to ensure that the work is progressing on schedule and that the loan is "in balance."

The forms include the balance needed to finish the construction, certification from the architects indicating the percentage of completion and confirmation that the completed work meets the standard specified in the contract.

This information is very important for the lending company to speed up the approval of any draw requests.

READ MORE: How to fire your home contractor

Title insurance

The lender typically requires the issuance of an American Land Title Association Commitment for Title Insurance by the time the loan closes, in an amount equivalent to the loan. Every time the contractor plans to request a draw from the unreleased loan proceeds, the lender typically contacts the title company to update the title from either the date of the policy or the time it was last updated.

Assuming there are no unfavorable changes, the title company will issue an endorsement certificate that will increase the amount of the policy's coverage by the amount of the outstanding draw.

The cumulative effect is that the coverage amount available under the insurance policy will be the total of funds reimbursed, based on the requirements of the pending reimbursement provision.



More From Bankrate.com