Draw Schedule in Private Lending: How to Get It Right

Many private lenders base their loans on the after-repair value of the home. An efficient and orderly renovation process is essential to reaching that value. This is why private lenders often hold the construction budget in escrow. By releasing this budget to the borrower in a series of draws, they ensure that the renovations are indeed taking place. The document that governs that process is called a draw schedule.

In private lending, a draw schedule is an agreement between a borrower and a lender on how to manage construction reserves held by that lender. It documents:

• The total amount of money held in reserves
• The number of draws required to disperse it
• The amount of money released in each draw
• The conditions under which the lender releases it.

For a new real estate investor, creating a detailed draw schedule might feel like a bureaucratic hoop to jump through, but it’s anything but. It’s probably the most important document that will govern your relationship with your private lender from the moment you close your loan to the moment you pay it off. Quite simply, in private lending, a draw schedule tells you what you need to accomplish to get the money you need.

How to create a draw schedule that is clear and easy to follow.

Start with a scope of work

A well-written draw schedule is based on a well-written scope of work. The scope of work is a detailed description of what your renovation process would consist of and how much it would cost. Scope of work is used to determine the after-repair value of your property. Once you complete your scope of work, you send it to your private lender for review. Your private lender would then forward it to their appraiser. The appraiser, in turn, would use it to find properties rehabbed to the same extent to use as comps to determine that future value.

Scope of work is also important because it guides your work with your contractor. Because of that, it’s developed in close collaboration with that contractor and other vendors you plan to use. We’ve written in the past about how to write an awesome scope of work. You can read all about it here. However, to recap, the scope of work needs to be as detailed as possible to avoid misunderstanding between you and the contractor. Here are just a few tips on how to ensure staying within your original budget.

Scope of Work: Best Practices

• Make sure that your contractor confirms in writing (email works best) that he agrees to the final version of the scope of work. Keep your emails for future references.
• Confirm that the scope of work is comprehensive enough to cover all the work that should be reasonable for a professional contractor to anticipate. Let me explain what I mean here. If you are adding a brand new bathroom in your basement, your plumber might give you a quote that includes installing a shower, a toilet, and a vanity. However, if later on, he charges you extra for installing the water lines, it might be deceiving. Water lines are a basic necessity for a functioning shower, so it would have been reasonable to assume that such necessities are automatically included in your agreement.
• Probe your contractor whether he foresees any issues with the renovation process. After all, he is an expert and needs to be able to anticipate potential probklems.
• Ask to approve any charge orders in advance and in writing.

Once you feel confident about your scope of work, it’s time to get cranking on that draw schedule. If your main collaborator on the scope of work was your contractor, you would be developing your draw schedule in close consultation with your private lender.

Work closely with your private lender

The first question you need to ask your lender is how many draws they will require. Private lenders rarely release more than $20K in a single draw, and many draws are less than that. So if your rehab budget is $100K, you can count on at least five draws. If it’s $30K – on at least two. However, do not assume anything: pick up the phone and ask. And while you have your lender on the line, it might be a good idea to delve into these additional questions.

Five Draw Schedule Questions to Ask Your Lender About:

• How many draws are required? See above.
• What are their requirements to release a draw?

Requirements vary from lender to lender. Some require receipts. Some only accept work done and documented by a licensed contractor. At New Funding Resources we require the work that was supposed to be done to be actually… done. That’s that simple. For example, if the conditions for the next draw are to install a furnace and AC and to rebuild the back porch, these items need to be completed in order for the money to be released.  

• How do they verify the work is completed?

Typically, a party representing the lender will arrange for an in-person inspection to take detailed pictures and videos of the progress. A lender then reviews them in order to make a decision whether the progress justifies releasing the next draw.

• How long does it take to receive the draw?

How fast the draws are released varies greatly from lender to lender. Though it’s an important question to ask upfront, you will never know for sure until you actually go through the process.

• How much do they charge to process the draw request?

Typically, the draw fees are charged per draw and collected in advance at closing.

Once you have clear answers to those questions, you can take the first stab at developing a draw schedule. A sample of a draw schedule used in private lending can be downloaded here. Once you are satisfied with the first draft, you need to share it with a hard money lender you use. They might have some questions and suggestions. It’s also an excellent idea to loop in your contractor since he will be responsible for actually doing the work. The final draw schedule then becomes a part of your loan closing package and is be signed by you at closing.

Borrower’s Responsibilities Regarding Draw Schedule

Plan for the First Draw

For most hard money loans, draws are released retrospectively: the work needs to be accomplished for the draw to be released. That prevents a borrower from borrowing money from a hard money lender and using it to take an elaborate vacation instead of renovating the house. What it means for you though is that you need to write a draw schedule in a way that allows you to complete the first draw requirements entirely on your own. The most obvious way is to have enough money remaining on your accounts. Alternatively, borrowers might use credit cards or arrange retrospective payments to their contractors.

Maintain Adequate Reserves to Meet Unexpected Expenses

Remember, the draws are paid based on the work accomplished and not on how much you spent. That means if you come under budget, you would still receive the entire amount set aside for your renovation. Alternatively, if some elements of your rehab are more expensive than you’ve initially anticipated, you would need to come up with that difference. This is another reason to maintain adequate reserves for the duration of your loan.

Do Not Unilaterally Change Your Draw Schedule

The draw schedule is an agreement between you and your private lender that has a direct impact on the key figure used to underwrite your loan – the after-repair value of your property. For this reason, you cannot unilaterally change your part of the bargain while expecting your lender to continue to release the same draws. After all, you probably wouldn’t like it if you lived up on your end of the bargain, but instead of releasing $20K, your lender released $10K – just because they changed their mind.

Maintain Close Communication with Your Lender

Communication is the key. Your lender’s and your financial goals are aligned. Both of you are interested in your rehab to be completed as soon as possible and your hard money loan to be repaid. Any delays in the rehab process are as detrimental to your lender as they are to you. Talk to your lender if you are experiencing significant challenges completing the items on your draw schedule. A reputable private lender should be able to offer guidance and flexibility on how to proceed without jeopardizing the process further.

Be a Good Bookkeeper

Your lender might be releasing the draws based on the work completed, but it’s how much money you’ve spent that is actually affecting your profits. Are you coming under budget or over budget? For your next rehab project, should you use the same cost projections or adjust them up or down? It’s important to keep meticulous records of your expenses, if not for your lender, then for yourself. If you are like me and having difficulty staying organized, use one of those tracking apps such as Home Budget or Expensify. Alternatly, read more on how to track your renovation expenses without overwhelming yourself.

Private Lender’s Responsibilities Regarding Draw Schedule

In private lending, a draw schedule is an agreement between the two parties. The borrower is not the only party that has responsibilities. The lender does too.

The main responsibility of the lender is to release draws quickly. Managing draws is an essential part of what’s called loan servicing. Loan servicing refers to the administrative aspects of a loan – processing payments, answering questions, collecting default interest, and yes, managing the escrow accounts. Truth be told, new real estate investors rarely consider loan servicing in deciding which private lender to use. Instead, they are primarily focused on interest rates and fees. However, efficient loan servicing is as important in keeping the borrower’s cost down as competitive rates. Let’s consider this example.

You borrowed $200,000 from a lender A with an interest rate of 10%. Your brother Ben borrowed the same amount from a lender B who charges 11%. Both of you have a construction escrow of $80,000 requiring 3 draws. Who is getting a better deal, you or Ben? You might be paying a lower interest than Ben. However, if your lender is skimping on servicing and takes longer to release your draws, you might end up paying more for your loan than Ben. If lender A takes two weeks longer to release each draw, it would take two months longer for your to finish your project than for Ben. If Ben holds his 11% loan for 6 months, he would pay $11,000 in total interest to lender B. In contrast, if you hold your loan for 8 months, you would pay $13,333 in total interest to lender A. Who is getting a better deal now?

Local Lenders Are Well-Positioned for Efficient Draw Release

We’ve written at length about how to select a private lender able to deliver the best value to a borrower. Being a local company is one of them. There are at least two reasons for it. First of all, a local lender located near the property can get to it faster and easier than a national company two time zones away. It’s not that those national lenders do not tap local resources like appraisers and home inspectors. They do, but it adds complexity not experienced by a local private lender.

The second reason is the levels of bureaucracy that are often present at larger national lenders. Once the property is inspected, the report goes from one department to another for a draw to be released. This is not the case with smaller local lenders that are typically privately-owned and where many decisions regarding the draws are made by a single person – typically the owner.

Summary

Escrow release is typically one of the most significant bones of contention between a private lender and a borrower. A well-written draw schedule is an essential element of a successful relationship with your hard money lender. I hope this article offers you useful and actionable information on how to manage this aspect and build a thriving real estate investing business. With any questions, please do not hesitate to contact us.