While working as the vice-president of construction and onsite project manager for the construction of four high-end houses in Newport Coast in Southern California…the construction lender could not entirely cover the hard-costs for houses having sales prices of $6.75 to $12.5 million…each house exceeding their loan limits.
We therefore capitalized (owner’s equity) 18-1/2% of the upfront costs of the construction budget, paying out-of-pocket for the concrete work and part of the lumber costs. The idea here is to postpone the disbursement of construction loan funds to a later point in time during the construction…so as to start the clock for loan interest costs beginning part-way into the total project duration…rather than paying interest on construction disbursements for the entire duration of an 18-month construction schedule.
I also worked for nine years as a construction manager for a bank. Several savvy single-family builders manipulated their construction disbursements to minimize loan interest payments. Even though the construction budget lines itemized on the construction loan document have the required funds for each category of the work…the borrower is not required to withdraw/use funds for every budget line-item during the course of the construction.
Some borrowers would complete and sell the new house, close escrow and pay-off the loan…yet still have unused funds in several categories like HVAC, flooring, landscaping, supervision, and builder’s fee…thus not paying interest on the funds leftover in these line-items. This is a perfectly acceptable approach by the builder/borrower…using out-of-pocket funds for some activities rather than taking disbursements that come with loan interest costs.
The construction lender is required to adequately “fund” the new construction project…but the borrower is not required to use all of the funds itemized in the budget.