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Case Study: Manual Construction Loan Process Leads to Undocumented Draw
Contract Simply is now Rabbet. We’re the same company – just with a new name – building the only intelligent construction finance platform. The content of this post has been preserved with the Contract Simply name.
The phone rings. It’s your accountant telling you that your bank overpaid a construction draw by almost $50,000 and the bank had no record of this payment on the amortization schedule. What do you do with this money? That is precisely the decision a Doctor had to make with two months left until completion on the renovation of a recently purchased medical building for her new branch. Let’s break it down to see how a manual construction loan process can lead to errors like this and why it needs to be a relic of the past.
First, the High Level Facts
This project is a commercial renovation with a $700,000 loan on a $900,000 total cost. The loan came from a top 10 construction lender in the U.S for a doctor to expand a new branch with additional space to lease out.
Below (Exhibit 1) is the draw request from the borrower that was wired by the bank in full for $44,842.32. This amount is the crucial number in this scenario shown by the draw request cover sheet:
Exhibit 1: draw request cover sheet from borrower
It took the accounting team just a minute of number crunching to realize the discrepancy between the borrower’s Quickbooks and the bank’s loan amortization schedule. Exhibit 2 (below) shows the accountant’s discovery that the number in question (missing from the bank’s amortization schedule) directly matched a previous draw request for $44,842.32.
Exhibit 2: accounting team’s worksheet discovering the imbalance
In a nutshell, a $46k draw disbursement was made to the borrower without being logged and applied to the loan. This means that the borrower received an undocumented $46k and will not have to pay interest or principal back on that amount.
So now you might be thinking: how could a top 10 construction lender let something like this slip through the cracks? Surely they will figure it out sooner or later? Let’s break it down and see why this is not an outrageous occurrence. With the dozens of construction projects looming over one desk, it is likely that the loan admin:
- Received the draw request
- Received sign off from the construction inspector
- Attained the appropriate approvals and signatures internally
- Disbursed the funds
- Forgot to log the draw against the loan in an Excel spreadsheet
- Went home for the evening frustrated by the monthly construction draw request crunch
Forgetting to manually enter one data point resulted in a whoopsie that was a whopping 6.5% of the total loan value. If you are thinking: that sounds like an average interest rate on a construction loan with this profile…you are right!
A phone call was made from the accounting team to the bank asking for an explanation of this discrepancy. The bank’s response to the phone call came in the form of an email with the exact same amortization schedule originally provided from the bank to the borrower. It was still missing the $44,842.32.
The accountant responded for a second time (Exhibit 3) explaining for a second time that this amount was still missing. There was no further communication after this second explanation.
Exhibit 3: accountant’s email back to the bank
If you ever misplace this much money, you will wish that the accountant on the other end gives you an opportunity to own up to your mistake like this accounting team did twice. The only difference is that you will accept the act of good faith.
So what could have prevented this mistake? We describe this scenario as a mistake because that is precisely what it is. With every individual construction loan having several layers of manual data entry containing fragmented documentation, it is an inevitability that items or steps will be missed.
After all of this…what is the solution? Well for starters, Construction Loan Software prevents this scenario from even being a possibility. A construction lender should spend time addressing red flags, not hunting them down.
The Ideal Construction Loan Software Solution
- Machine learning and automated document processing extracts all information, reconciles invoices with budget line items, and a highlights errors.
- Approval workflow tools to automate requests for reviews and signatures prior to disbursement.
- Project flexibility with turnkey standardization.
- Payment processing that releases payment to contractors in conjunction with lien waivers.
- Real-time reporting with both project and portfolio-level dashboards give visibility into the health of the overall construction loan management process.
And what did the borrower do, you ask? The borrower, alongside her accounting team, decided to leave the situation alone keeping the $44,842.32 on the books as a loan payable until the construction loan had been fully serviced.
At this point in time, the team quietly cheered in the beautiful newly renovated office for having received an essentially interest free loan and recorded the $44,842.32 as income.
Someone once said that there is no free lunch, but there sure is if your construction lender fudges the documentation around $44,842.32 and it covers your interest cost!
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About Contract Simply
Contract Simply is the leading software for construction lenders and construction loan management. Everything we do – from rapid fire document processing to payments to lien management – is designed to improve efficiencies and mitigate risk through process automation.
Built in Austin, Contract Simply offers cutting-edge machine-learning technology and more efficient logic to manage construction loans, cutting days from the construction draw process while ensuring compliance and reducing risks for everyone involved.
Lenders love Contract Simply because its machine learning algorithms help automate mundane tasks and accelerate the approval process usually managed in large siloed Excel spreadsheets.
Borrowers love Contract Simply because it simplifies the tedious nature of submitting draw requests and expedites draw disbursements.
Lenders and Borrowers log into the Contract Simply portal to quickly share and review draw requests, documents, invoices, receipts, lien releases, inspection reports, and overall project and payment progress. Everyone spends less time reviewing paperwork and waiting for payments, and more time completing projects.
Contract Simply – providing intelligent automation of construction payments!