Construction loan risks can be costly if not managed well. When a lender is well aware of the risks involved in construction loans, they can identify them in a timely manner and develop strategies to mitigate them before something goes wrong. Here are common construction loan risks you should avoid.
Failure to complete a project within the interim construction period deadline
When a budget is managed properly, funds can run out before the project is completed, making it risky for the lender. To avoid such a scenario, ensure that the funds you release to the builders are equal to the percentage of works completed, as verified by the construction progress inspection. Therefore, it is essential to maintain balance and carry out inspections until the end of the project.
Outsourcing independent review services to a company like Northwest Construction Control will ensure lenders are efficiently monitoring the project in accordance with best practices and will help expedite draw inspection and offer comprehensive risk mitigation solutions. Additionally, the lender must ensure that the construction loan is always balanced, that undisbursed funds are sufficient to complete improvements, and that disbursements are only released for completed work.
Low or no contingency budget
If you do not factor a contingency budget into your overall construction cost estimate, any unexpected expenses will increase the budget, causing delays or preventing the potential completion of the project. Additionally, unintended repairs may arise due to health/safety concerns, or other unforeseen factors may increase the budget, compromising project completion time. Adding a contingency amount to your financing will help avoid such problems.
Lack of progress reports
Progress reports allow you to monitor the project to ensure it is on schedule according to the loan term and completion date indicated in the construction contract and loan agreement. Additionally, progress reports allow you to ensure consistency between construction work and any withdrawal request funds requests. You can hire progress inspection services to check that application requests are in line with improvements made and check other financial issues.
Failure to protect your first lien right
Lien waivers ensure fair payments and are used to protect a lender's lien position and help avoid liens that complicate and delay projects. Since construction loans have multiple properties, lenders must maintain a first lien to avoid losing control of the disbursement of funds. Different states have different forms of collateral, and ensuring you obtain the correct documents will help you mitigate risk. As a best practice, ensure that warranty waivers are completed in accordance with state and local regulations, that you complete the correct waiver form and submit it on time, and that you only pay for completed work and current materials .
Missing or incomplete budget and project documentation
To reduce this risk, lenders should consider performing detailed project reviews or hiring a qualified person to perform pre-loan closing checks to save time and money in the event of a construction contract dispute. When the budget or documentation is incomplete or missing, unforeseen extra expenses increase the risk of default. Make sure the review includes an appraisal report, permits, budget, and construction contract review.
Final grade
As a lender, you must know the loan risks you may face to avoid or create strategies to manage the risks. Add these risks to your list of potential loan risks to ensure success and profitability.
