Is Construction Loan the Way to Go?

Barrett and his wife are about to close on a house that needs some remodeling. They are thinking about a construction loan to protect themselves because the bank must approve the work.

QUESTION: Barrett in Texas and his wife are about to close on a house that needs some remodeling. They have the cash to do that, but they’ve heard about contractors who rip people off. They are thinking about a construction loan to protect themselves because the bank must approve the work. Dave has an idea of how to fix this that cuts out the bank’s role.

ANSWER: Why not just not pay the contractor until you’ve seen the work done? You may not be into construction, but neither are bankers. They just have guidelines that say at certain levels of repair, certain amounts will be drawn.

Get at least three quotes and see a breakdown on those quotes and what is involved with them. Are there allowances, or is this a turn-key? Allowances are where you say they can spend a certain amount on the granite. If you go over that, you need to find out if you can buy granite for that. If it’s a turn-key quote, they are furnishing granite at that price.

If the job is going to go in phases of some kind, and they want certain draws along the way, then just clearly lay that out. That needs to be something in the agreement that you understand. When the cabinets are installed but not the countertops, you get a certain amount of money. When the countertops go on and the plumbing is installed, you get a certain amount of money. You can look at that and make the call.

But do not let the contractor get ahead of you. You always need to be ahead of the contractor. That means if they walk off the job, they are losing money. So if they walk off the job in the middle, you just get somebody to finish the job. You’ve got all the money needed to finish the job because they have not yet been paid for that portion of the job that has not been done. Don’t get behind them where they’ve got more money than work done.

Don’t front the money. If they are so broke that they need you to front the money, you’ve got the wrong guy. In that case, they are calling the cabinet guy, and the cabinet guy is installing the cabinets and sending them a bill. They didn’t put any cash in there. Then when they get the bill, they need to be able to pay the bill. Well, the cabinets are installed, so you can give them a draw so they can pay the bill. But they don’t need money up front to pay for the cabinets. The cabinet bill isn’t going to be paid until after the cabinets are installed. So you’re not going to pay the bill until after they’re installed.

If they can’t cover their own labor on odds and ends or painting or whatever else is going on, that’s fine. But you do not get behind with them, because they may leave the job. If they leave the job, you still have to have the money to finish it. That’s all you’ve got to do.

Whatever draw points there are, you need to understand them so you can clearly look at it and say, “No, we’re not at that point.” You don’t draw unless you’re there. Don’t get underwater with them. The second thing is to remember the overall principle that you don’t let them get ahead of you. Get three bids and interview them carefully and check their references. Go physically look at their work, because this is a big job you’re contracting out. Take some time and invest in the process. Really learn about it.

Don’t try to do the least possible amount of work on your part and hope you have a good result, because you won’t. It will turn into the remodel from hell. Also, put some penalties in there if they don’t finish it on schedule. You don’t want something that takes 30 days taking six months to finish, and you’re left there eating dust with no kitchen. That needs to be costing them money. That keeps them on the job.