1. HOW ARE THE FUNDS FOR A RENOVATION LOAN DISTRIBUTED
There are two answers to this question of how our renovation loan funds are distributed. First, understand that there are two types of renovation programs. One program known as the FHA streamline renovation, where the amount of money for the renovation is less than $35,000, and there are no structural issues, is considered a streamlined renovation. With a streamlined renovation, 50% of the money is typically released upfront, and the remaining 50% is released upon the project’s completion. Usually, a consultant is not present for a streamlined loan. However, we encourage a consultant on streamlined loans to ensure that the repairs are being done in a workmanlike manner, on time, and within budget, and to be the liaison between the contractor and the homeowner. The second program is a total renovation loan. Many times, a person had thought that they would be doing a streamlined renovation program only to find out that when the appraiser looked at the property, that person determined that there were issues such as dry rot or other conducive conditions that predicated the fact the loan needed to be converted from a streamline into a complete renovation. Many times, it has turned into a complete renovation program. The reason is that structural damage and dry rot were discovered during the appraisal process, and the homeowner never had an inspection done. Now, we are blindsided and behind in closing their loan. The only difference between a streamlined and complete renovation is the cost; the paperwork is substantially more for a complete renovation program. The funds for a full renovation are released on a draw basis. The consultant will inspect the property and, per line item, determine the percentage of completion for the progress of each line item and thereby assign a value to be released. The consultant provides the paperwork to the lender along with documentation of the progress on the property. The lender will then issue a check to both the homeowner and the contractor. Usually, both parties will sign the check, and the contractor will deposit the check into their account to pay for the project to that point; it should be noted, though, that on each draw, the contractor will also sign a lien release document stating that no liens have been placed against the property during the construction ensuring that all of the subcontractors have been paid to date. When the final draw inspection is performed, the contractor will sign a final lien release waiver form, ensuring no liens have been placed against the property.
2. WHAT IS THE “HOLD-BACK” FOR THE DRAW INSPECTION
The holdback on a draw inspection is typically a percentage of the overall amount to be released. That percentage is usually 10%. As an example, assume that your first construction draw equals $20,000. The lender will hold out 10% and, in this case, $2000, and the net amount released for payment would be $18,000. The reason for a 10% holdback is to ensure that the general contractor completes all of the work as described per this Specification of Repairs (SOR). Unfortunately, it has been commonplace for contractors not to complete the work on a project and take all of the funds, leaving a homeowner asking how to finish their project. This is a protection mechanism put in place to protect the homeowner. They hold back money; the 10% from each draw is typically put into an interest-bearing account and is released to the homeowner and contractor on the final draw of the project.
3. CAN I GET MONEY UPFRONT
The answer to this question is yes and no. If the renovation is a streamlined program, 50% can be released up front, and the remaining 50% will be released when the project is done. That is just for a streamlined. Under a complete renovation program, typically, no monies are released upfront. However, with the exception, a lender could authorize the release of 50% of funds needed for depository-type items such as kitchen cabinets that need deposits. If you are doing a complete renovation, you should not expect to receive any monies upfront. With that in mind, when hiring a general contractor, the lender reviews the contractor’s documents and performance and has information from the GC about their financial condition. Choosing a GC, and having an honest discussion about their financial positions would behoove a person. Such things in the conversation might include references of other clients they have worked for and the names and references of suppliers they have established accounts with to ensure that they pay their suppliers. During the vetting process of a lender for a contractor, the lender typically approves a contractor. However, they can disapprove a contractor based on any negative financial information about the contractor.
4. WHAT IF THERE ARE UNFORESEEN CONDITIONS DURING THE CONSTRUCTION
Unforeseen conditions are defined as conditions that arise during the construction and remodeling process. These may be concealed situations not identified during the inspection of the property, such as dry rot or damage concealed behind a wall. There could be other unforeseen conditions not specified in the beginning that may need to be repaired. If this situation occurs, which it frequently does in remodeling, a renovation loan has what is referred to as a contingency factor. The contingency factor can range in percentage from 10%, 15%, or 20% of the overall amount of the project. For example, if the renovation cost is $100,000 and there is a 10% contingency, that would equal $10,000. 10% contingency is the average standard contingency rate for a renovation project. However, a 15% or 20% contingency can be put into effect based on the condition of the property. For example, if the consultant considers there may be a lot of unforeseen conditions, there could be a 15% contingency instead of a 10% contingency. If the water and or power is not on to the property at the time of the inspection and the appraisal, the contingency usually is an automatic 20%. Typically, contingency is used for any unforeseen conditions. To release any portion of the contingency, the consultant will require the general contractor to provide a materials and labor invoice detailing the unforeseen conditions that were in place and have been corrected. Once it is determined that no other unforeseen conditions may arise, a homeowner can use the remaining balance of the contingency funds for further upgrades and improvements as long as those upgrades or improvements are non-structural. Usually, the lender may be required to approve additional improvements. Your consultant can help you with this. If the contingency funds are not used, the remaining balance will be applied to the principal of your mortgage, although it will not re-amortize the mortgage.
5. WHAT HAPPENS AFTER THE WORK IS COMPLETED
Upon completion of all of the work on the property, the homeowner and contractor would contact the consultant for a final inspection. At that time, the consultant would visit the property and verify that all work has been completed in a workmanlike manner and standards. The consultant would then complete all the necessary paperwork, including any final lien releases needed, and submit that to the lender. At the time of submission of the final draw, the lender will call the original appraiser to go back to the property and verify that all the work has been completed to industry standards and specifications. The lender also contacts the title company that issued the title on the property to have the title company perform what's referred to as a title date down. The title date down is a process in which the title company searches for any liens and encumbrances placed against the property during the renovation period. This process typically takes one to two weeks to complete. Upon completion, the lender will release all the remaining money in the renovation plus the 10% hold back and any contingency monies that have been accounted for.
6. WHAT IF I HAVE MONEY LEFT OVER FROM A RENOVATION LOAN
If a person has any money left over in savings from doing a renovation loan, there are two options for those cost savings. The first option is to give the cost savings back to the lender, and the lender will reapply those savings to the principal of your mortgage, although they will not re-amortize the mortgage. Your payment will still be the same amount of money. The second option will be to use the funds for further upgrades and improvements if those upgrades and modifications are not structural. That might include such things as landscaping or other minor improvements or upgrades.