Construction lending requires accurate, timely draw disbursements to keep projects moving while protecting the lender’s collateral position. Occasionally, a contractor or borrower submits a draw request that exceeds the progress documented in the most recent inspection report. The inspection is an opinion of work in place and is not an exact science. When discrepancies exist, there must be a reasonableness test before amending a draw. Lenders must take a structured, risk-aligned approach to either increasing the percent complete using best practice guidelines and/or amending the draw amount which leaves builders/borrowers feeling frustrated.
1. When the Draw Inspection Doesn’t Support the Amount Requested
A third-party draw inspection is designed to verify that the percentage of work completed aligns with the funds being requested. If the inspection does not support the requested amount, it signals a potential misalignment between actual progress and projected progress.
Common causes include:
• Over-billing by the contractor
• Timing differences between work performed and inspection date
• Change orders or scope shifts not fully documented
• Discrepancies between the inspector’s % complete and the builder’s % complete
Regardless of the source, this mismatch requires the lender to intervene and determine an appropriate adjustment.
2. Adjusting the Draw Based on Internal Risk Policies
When an inspection report indicates insufficient progress to justify the draw request, lenders should apply their internal risk management policies to determine whether and how much of the request can be safely funded.
Key lender considerations include:
• Pre-close underwriting exceptions on the Builder or Project Review.
• Borrower credit profile and related strength
• Builder/Borrower performance history
• Overall project health and contingency availability
• Whether the discrepancy is isolated or recurring
• Current loan-to-cost and loan-to-value exposure
• Market and collateral considerations
The layering of exceptions is critical to managing the post-close disbursement process. When exceptions are made pre-close (builder or project exceptions) then the post-close draw process should be carefully monitored. While accommodating the draw may help maintain project momentum and customer service, the lender must ensure that disbursements remain tied to verified construction progress. Internal policies should guide the decision on how much flexibility is appropriate.
3. Recommended Adjustment Guidelines
To balance project continuity with prudent risk management, industry best practices suggest the following guidelines:
Maximum 10% Adjustment Per Line Item
If a specific line item shows less progress than billed, the lender may allow an upward adjustment of up to 10% above the inspected completion level. This provides reasonable flexibility while limiting overexposure in any single construction line item. Additionally, the lender may impose a minimum dollar adjustment amount, for example $2,500. If the per line item adjustment exceeds the 10% variance, and the dollar amount is less than $2,500 then the total requested amount would be funded. The above policy applies to all drawn line items not zero requested line items. The lender may set its own line item variance policy based upon its risk tolerance.
Maximum 10% Overall Project Completion Variance
Across all line items, the sum of adjustments should not exceed 10% of the total disbursements as compared to % complete. This cap helps ensure that the total disbursement remains closely aligned with verified site progress. On a $1,000,000 project that would equate to $100,000 for overall inspection variances throughout the budget.
These thresholds provide a structured, transparent way to accommodate minor variances without compromising the lender’s collateral position while maintaining flexibility with the builder for repeat business; however, variances can be adjusted by the lender based on the borrower’s credit profile and/or the builder’s history with the lender.
Conclusion
An inspection report serves as a disbursement guideline and requires the lender to reconcile the percent complete against the amount requested. When a draw inspection does not support the amount requested, lenders must balance project continuity and flexibility with sound risk management decisions while also considering the customer service aspect. Builders don’t like to feel nickel and dimed. A flexible variance policy leads to happy builders/borrowers and repeat business. The key is establishing a variance policy that fits within the lender’s risk tolerance. Afterall, it’s a risk mitigation process not a risk elimination process.
Contact us today to strengthen your construction lending process with variance policies and draw review practices that keep projects moving while protecting your collateral from unnecessary risk.