How Construction Loans Are Paid

In today’s TMYK, we cover the way banks pay home builders.

Say you hire a plumber to fix your sink.  Before he begins work, he tells you that he needs to buy supplies to complete your repair and demands a check for $50 before heading off to the store.

If he’s an honest plumber, he’ll come back and finish the job, but he could just as easily skip town with the cash.

Now imagine how your bank feels when they are asked to pay a builder for a several hundred thousand dollar construction project. Imagine how your builder builder would feel if he had to complete the project out of pocket only get paid on completion.

Fortunately, there is a better solution.  Construction loans are structured such that the bank itself performs regular inspections and is kept up-to-date with the actual progress on-site.  The bank pays the builder for completed construction, not materials on-site.  That means they don’t get paid for a stack of trusses and windows sitting in the front yard.  Frequently, the builder sends a request for payment to the bank at the end of each month.  The  bank then sends out an inspector on or around the 1st to verify all of the specified pieces have been completed.  Banks sometimes allow extra payments partway through the month, but at a fee charged to the builder.

In essence, this is like you sticking a dollar in the plumber’s pocket each time he completed a step in your sink repair.  For big projects, this is a fair and reasonable way to ensure that both the bank and builder each hold up their end of the bargain while not putting either into too much financial risk.