Confounded by contractors? Lost your way with lien waivers? Daunted by disbursing? You’re not alone! Construction disbursing is one part of rehabbing that most of our clients don’t understand well. But we’re about to clear it all up for you.
What, exactly, is construction disbursing?
It’s a system designed to distribute rehab funds as work is completed, rather than giving the borrower all of the funds up front.
The lender or a disbursing company holds your rehab money in an escrow account.
As work is completed and materials have been installed, they distribute that money out to you and your contractors.
When a hard-money lender lends to someone, for example, on a $100,000 property needing a $50,000 rehab, the loan will be approved for the full amount of $150,000.
In this case $100,000 will be used to purchase the property, and $50,000 will be transferred to a disbursing company for the rehab.
At this point some borrowers ask, “Why are we paying interest on rehab money we haven’t even gotten yet?”
It’s simply because the hard money lender is paying interest to the bank for the whole amount they borrowed to lend to you.
When should you use disbursing?
If you’re doing a project that requires $30,000 or more in repairs and you don’t have a lot of cash on hand, disbursing is a perfect option for you.
If you’re doing a smaller project and you have available cash, disbursing really isn’t worth it. The disbursing company is paid a flat fee to manage your funds, no matter how few draws you take.
On smaller projects, use your own cash and pay your contractors out of pocket. Just be sure to collect all of the lien waivers as you would with disbursing.
Count the Cost
Disbursing is not free. Be sure to ask who holds the money and what the cost will be!
Lenders sometimes disburse the funds themselves. This may seem simpler, but there are some downsides:
Lenders don’t do disbursing all the time. They may have a clunky process for reimbursement, or they may not be familiar with all of the documentation needed to protect the borrower from liens.
Lenders may have rehab funds in a general account, potentially using them for other deals rather than keeping them in escrow. There is a risk that the funds may not be available to you when you go to take a draw.
A third party disbursing company holds the funds in escrow after closing. Each one does things differently, so ask questions until you understand all of the terms.
Ask what the cost will be, and understand how many draws you can take.
Get to know their process thoroughly.
Ask about their turnaround time on draw requests.
If you have your choice of title companies, choose one with an excellent disbursing company! We are happy to make recommendations.
Why hold funds so soon?
Why does the rehab money go to the disbursing company so soon, before we even start the work?
This way the borrower can rest assured that the full amount of rehab funds have been put aside for them and that the lender won’t lend the funds to someone else, leaving them short of money for the needed repairs on their property. Imagine going to make a draw, and finding the funds are no longer available!
Similarly, the lender can rest assured that the borrower won’t jet off to Turks and Caicos on a dream vacation instead of rehabbing the house.
Having the rehab funds in escrow with the disbursing company mutually protects the borrower and the lender.
How it Works
If you choose to use disbursing funds, you will sign a disbursing agreement at closing. The disbursing company is associated with the title company you’re closing with.
For example, if you’re closing with True Title, you’ll be using Q-Draw. With Investors, Insight, Freedom, or Vision, you’ll be using Accurate Disbursing. Old Republic and Continental have their own in-house disbursing companies.
Each disbursing company has its own internal process for reimbursements.
Whenever a portion of the work is completed you will submit a draw request, ideally every few weeks. You shouldn’t wait until all of the work is done and take one big draw at the end.
At closing, any remaining unused funds are credited to you on the settlement statement.
A Budget with Bounce
Budgeting is your FIRST STEP when using disbursing. So how do you put together your budget to give to the disbursing company so that it works efficiently and flexibly for reimbursement?
Keep the categories broad in your initial budget.
For example, a category for “Kitchen” could include appliances, cabinets, countertops, sink, and backsplash. Another category for “All Bathrooms” might include a tub, shower enclosure, vanities, tile, and light fixtures.
Using broad categories in your budget gives you the flexibility to bounce funds around from one category to another if something unexpected comes up, such as needing to replace a plumbing stack.
You can more easily move funds around because you can clearly see where you are under budget in one or more of the broad categories.
The disbursing company wants to help you stay on budget. Just let them know how you want the funds reallocated in your budget categories.
You’ve started your project. You’ve done your demo. You’ve got your roughed-in plumbing and electrical completed.
This is the perfect time to take your first draw!
You can do it one of two ways:
Option 1: Your plumber and electrician can be paid directly. Make this known up front to both the disbursing company and the contractors. Ask contractors to go to the disbursing company with their invoices and lien waivers to be signed there. Bonus: You’ll have fewer 1099s to issue at the end of the year, since the disbursing company paid the contractors directly!
Option 2: You provide receipts and signed lien waivers to the disbursing company showing that the work has been done and the contractors have been paid by you. The disbursing company will then reimburse you. Every few weeks, look for a logical place in your progress where it would make sense to take a draw – and do it!
Whichever option you choose, you will need a signed lien waiver from every contractor, subcontractor, and supplier involved in the work on the house.
Let’s say a roofer installs the roof, and he provides a paid receipt and signed lien waiver. However, the roofer might not have paid the shingle supplier. The shingle supplier can then put a lien on your house!
Be sure to get a lien waiver from every supplier of materials. This principle applies to all building and finishing materials: siding, windows, cabinets, flooring, etc.
Exception: If you buy materials from a big box store (ie. Home Depot, Lowes, Hoods), you just need a receipt from them, not a lien waiver. Any items bought for personal use like water, chips, and items for your own home, need to be on a separate receipt. Otherwise, you’ll need to separate those items out of the receipt before you submit it.
Insist on getting a signed lien waiver at the same time you give a contractor their payment. Accept no delays or excuses. Protecting your property from liens is essential. Let nothing stand in the way of your sale or refi when the time comes!
Although most rehabbers are confused by construction disbursing, you are no longer among them! If you found disbursing daunting before, you can now budget boldly, take draws daringly, and command your construction funds confidently!