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Building a home? You can pay your contractors right out of your loan with a draw. Bankrate explains.

What is a draw?

A draw is a payment taken from construction loan proceeds made to material suppliers, contractors and subcontractors. That means the borrower doesn’t have to pay them from personal funds while the project is ongoing. Draws also keep vendors happy because they’re getting regularly paid.

Deeper definition

Almost all construction loans have extra funds that are withdrawn immediately and deposited in a locked account called an “interest reserve,” which is based on the project’s construction budget. Because the construction project can take a long time, contractors, material suppliers, and members of the construction team need to get paid at different stages. That’s when they draw from the construction loan.

Draws offer relief to borrowers from having to meet expensive payment schedules. Borrowers also don’t get penalized by the draw, since they usually only have to make interest payments on the principal.

Draws usually begin upon completion of a pre-designated stage, such as building under roof or pouring of the foundation. It also may occur periodically, typically once a month for the specified term, followed by a “final draw.” They’re subject to approval from the creditor, who verifies that the stage has been completed according to the terms of the contract.

Do you owe money on a loan? Bankrate can help you dig yourself out.

Draw example

Bob is a builder who can fix anything. He’s hired by Wendy to renovate her home theater. It’s an expensive job, so Wendy takes out a construction loan to help pay Bob and his subcontractors. Bob needs to buy new insulation for the home theater, and his materials vendor draws payment from Wendy’s construction loan to cover his costs. Once Bob begins, he estimates it’ll take six months to complete. After the first month, Bob needs to get paid. He shows Wendy’s bank that he’s met a predetermined construction milestone, and the bank lets him draw a payment from the loan for the month of work he performed.

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