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Understanding the Hard Money Draw Process

When you’re investing in a property and working on a rehab project, understanding the hard money draw process is crucial. This process involves the lender releasing funds based on completed work. Let’s break down how it works and avoid some common pitfalls.

Getting Started with Your Rehab Project

To kick off your rehab project, most contractors will need some money upfront. This occurs after your property has been funded and you have the green light from your lender. A good rule of thumb is to avoid paying more than $5,000 upfront. For larger projects, even $12,500 can be too much. Most initial work is labor-intensive, so manage these early payments wisely.

Contractor vs. Lender Relationships

There are two key relationships to manage here:

  1. Lender and Borrower: The lender releases funds to you based on completed work. These funds do not go directly to your contractor.
  2. Borrower and Contractor: You handle payments to your contractor based on progress and agreements made.

It’s important to keep these relationships separate. Your contractor’s payment schedule might not align with your lender’s draw process.

Handling Draw Requests

When you’re ready to get reimbursed for completed work, you’ll send a draw request form to your lender. This can usually be done online or through email. Once received, the lender orders an inspection. Make sure your contractor sends you photos of completed work to avoid unnecessary inspection fees.

The lender releases funds only for completed work, not for materials awaiting installation. For instance, if you order kitchen cabinets but they haven’t arrived yet, you won’t get funds for them until they’re installed and verified by the inspector. This process typically takes 2-3 business days.

Common Draw Process Mistakes

Let’s highlight five common mistakes and how to avoid them.

1. Giving Too Much Money Upfront

Paying your contractor too much upfront reduces their incentive to complete the work. For large GCs, a maximum of $5,000 upfront is a good limit. Hold back some money until the project is fully completed to ensure all tasks get done.

2. Accepting Poor Quality Work

Don’t rely solely on your contractor’s word. Verify the quality of the work yourself. If you’re frequently unable to visit the site, ask for regular updates and photos. Quality should never be sacrificed for speed or cost.

3. Requesting Funds for Unfinished Work

Ensure that the work you’re requesting funds for is indeed complete. Inspect and verify before scheduling an inspection with your lender. Adjust your draw request if additional items are completed to ensure you get reimbursed.

4. Misalignment with Original Estimate

Lenders only release funds for items listed in the original rehab estimate. Unexpected issues, like termites found after walls are opened, need to be accounted for in overages or reserve accounts. Always align your draw requests with the original rehab estimate.

5. Waiting Until Rehab is 100% Complete

While you might think you’re saving time and money by waiting until the rehab is completely done, it’s better to balance cost with job quality. Lenders can help spot issues early. Use their experience to ensure quality and avoid costly mistakes later.

Wrap-up

Understanding the hard money draw process is essential for the successful completion of your rehab project. By managing upfront payments wisely, maintaining clear relationships between contractors and lenders, and avoiding common pitfalls such as paying too much upfront or accepting poor-quality work, you can ensure smooth progress. Properly handling draw requests and staying aligned with your original estimates will keep your project on track. 

Remember, thorough inspections and timely adjustments can save time and money in the long run. With careful planning and diligent oversight, you can navigate the rehab process effectively and achieve your investment goals.

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