When you work with a hard money lender to finance your fix and flip, there is a possibility your loan will include a “holdback.” What exactly is a holdback and why would your lender want one as part of your contract?
A construction holdback is when your hard money lender helps fund your fix and flip, but “hold back” the construction part of the loan to gradually pay for the renovation of the property. Your loan includes a construction holdback because the property you are purchasing is serving as collateral on the loan; that means the loan will be recorded on the property’s title, in first position. If the borrower then defaults on the loan, the lender can simply foreclose on the property and recover the lost money. In most states, contractor liens take first position on a title; meaning that in the case of foreclosure, all outstanding balances due to the contractor are paid out before the lender receives any sale proceeds from the foreclosure. Therefore, if hard money lenders authorize the construction of a fix and flip, in the event that the borrower defaults, the construction crew will receive payment from the foreclosure sale, leaving a loss to the lender.
A construction holdback rarely affects loan approval or funding time at all. In the event that a hard money loanincludes a construction holdback all that is required of the borrower signs an agreement stating the details of the scope for the project’s construction plan. This agreement will also outline the terms and conditions connected with the holdback, and how the funds will be released.
Some borrowers request funds to pay their contractors in advance. Most hard money lenders will not rescind construction monies in advance. Generally, a holdback draw (money) is not advanced funding for construction. The draw, which is smaller amounts of the loan used for a specific purpose, matches the progress of the project’s construction. An inspector will typically come out to inspect the fix and flip’s progression and report back to the lender.
Depending upon your hard money lender and your holdback agreement, either you, the borrower, will receive the funds or the funds will be sent directly to your contractor. The construction holdback is a part of the contract that you need to spend time fully addressing and understanding with your lender before signing on the dotted line.
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About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 43 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.