In order to be a successful 203K contractor, a construction company must be able to operate under HUD's rules for the 203k loan program. Some of these requirements are quite contractor-unfriendly, so it can often be difficult to find a company that is qualified or even interested in doing this work.
Below are some of the rules and requirements for 203(k) contractors.
Challenging Cash Flows
The 203(k) process is designed to protect the bank and the homeowner. However, this makes cash flows very tough for contractors.
- Contractors do NOT get money up-front, except under very special circumstances. They typically have to be able to run 3-4 weeks of a project before seeing the first draw.
- All payments are made in arrears. So, a contractor can only bill for work that is completed. Most banks will not even authorize partial payments for materials stored on site. They must be installed.
- Even for work that has been completed, 10% is held by the bank until the end of the project. This retainage, as it is called, gives the bank and homeowner leverage should some aspect of the work need attention.
- Approved change orders to be paid from the contingency fund are typically not disbursed until the project is at least 75% complete -- even the changes are 100% complete. This can be particularly difficult for discovery issues early on in the project. For example, if a structural defect is discovered and addressed in the first week of the project, the contractor may have to wait 3-4 months before the bank will allow the contractor to bill for it.
HUD requires lenders to evaluate contractors' credentials and qualifications and to document these items. A contractor must have its local licensing, regulatory licensing, liability insurance, worker's compensation insurance, trade references and contract available for approval.
3rd Party Inspections & Delayed Draws
All draws are conducted by a 3rd party inspector (203(k) inspector) certified by HUD. These individuals come to the job site to determine what work has been completed and how much money the contractor is eligible to receive. This process adds time and complexity for the contractor. Typically, the contractor needs to prepare paperwork showing what work has been done. Then, it takes a few day before the package is signed by all parties and submitted. Then, the bank will take 2-5 days to process this information before sending payment to the homeowner. At that point, the homeowner has a check to hand over to the contractor.
When a contractor starts a 203(k) project, it usually has to begin work with no payment at all from the client. When the contractor does complete some of the work, it has to fill out complex paperwork to apply for a draw and meet a 3rd-party inspector on site to verify that it was completed. Then, the contractor has to wait approximately 7-10 days to get a check for this work, which was typically completed 2-3 weeks prior. And, that check is for only 90% of what's owed.
In our experience, between the billing in arrears, the delayed payment for change orders and the 10% retainage, we find that when we complete 203(k) projects, we only have about 60-70% of the contract amount collected. The rest trickles in two to six weeks after the project is completed.
Because we’ve completed so many projects funded by this program, New City understands and is prepared for these complexities.Our experience with the 203(k) loan process makes working with us so much easier for HUD inspectors, home buyers, real estate agents and loan officers. Because we’re experts in these projects, we:
- Understand each stage of the process and anticipate next steps; this keeps the project on schedule
- Accurately scope the project to meet local building codes and HUD guidelines; this keeps the project on budget and prevents unnecessary delays
- Manage our operations and cash flow efficiently to be able to work on projects that operate on a “pay-as-completed” basis