Understanding the Importance of Construction Escrow for Contractors, Material Suppliers and Lenders Involved

One of the biggest challenges contractors, subcontractors, material suppliers and lenders, making the construction loans, usually face, following a project’s completion, is getting paid for services rendered. As a result, they look for different solutions to ensure they receive what they’re owed by developers or project owners.

One of the most popular solutions in the market is an Ecrow Agreement. Many contractors, material suppliers, and top-tier parties use construction escrow to ensure they’re paid as long as they meet all their contract conditions. When it comes to Lenders, who finance a construction project, they always have an Escrow Agreement that spells out the terms, amounts and funds control in an escrow bank account.

In this post, we’ll share a quick guide to construction escrow accounts and agreements for contractors and suppliers.

Construction Escrow Explained
In layperson’s terms, a construction escrow or funds control is a construction payment account made and maintained in a third-party financial institution, such as a bank, to hold all the funds of a specific project. By creating an escrow account and signing an escrow agreement, all parties can ensure they will have sufficient funds for the project’s scope,and get paid for services rendered. This escrow account is managed by the lender or the third party, like an escrow company or funds control, who is the business of managing escrow funds for different projects and different lenders.
However, while escrow accounts and agreements guarantee payment, they don’t guarantee on-time payments, as the third parties managing the account take much longer to process them. Depending on the state, these parties can be a bank, insurance company, escrow company, funds control company or law firm.
All of these entities must have licensed escrow agents that have no affiliation with any party to ensure they remain unbiased when managing transactions.

Payment Distribution Using Escrow Accounts
Before any project commences, it’s the lender’sresponsibility to add funds to the escrow account created. Once done, the account is controlled by the third party managing those funds. Any party that requires payment for different processes or for work completed must submit a payment request or voucher or withdrawal request to the third party for disbursement of funds. Those said funds must be maintained in a trust account that is designed to have subsidiary ledgers for each client or for each project. In many states in the USA, those trust accounts are being audited by the authority in charge of overseeing them, to insure proper management and avoiding any theft by the managing company. In addition, those bank accounts are FDIC insured.

Most contractors request draws from the escrow accounts as soon as they complete different phases of their projects to ensure they have sufficient capital for the future. For example, to pay subcontractors for their work, pay for new permitsand other expenses associated with the project.
Once they send in a request, the escrow company sends an onsite inspection team or person to audit the project and determine if the amount requested matches the work completed before the next phase of the disbursement is provided. Next, the inspector drafts a report and submits the payment request for processing and approval by the escrow company for releasing the funds.

Benefits of Using a Construction Escrow or Holder of Funds for Contractors, Developers, and Third Parties

Contractors
Owners of self funded projects should have an escrow agreement in place and hire an escrow company/funds control company. Contractors signing an escrow agreement and having the owner opening an escrow account is an excellent way to reduce the uncertainty of funding and payment. Therefore, they can better focus on their job without being worried about getting paid for services rendered. Of course, they must submit the right paperwork and ensure their withdrawal requests match the completed work.

Developers/Owners
While every party that signs an escrow agreement is protected, the developers or owners receive the most protection. Although, they cannot delay their property taxes, since there certain due dates for them, and insurance premiums on their property, to insure proper coverage, in case there is a loss, they can protect themselves from non-project creditors and pay all parties without too much effort, as the escrow company will do most of the leg work.
However, to reap any additional benefits, the property owner must fund the account properly, if there is no bank financing involved. More importantly, proper funding can ensure every party is satisfied and can focus 100% on the project’s scope.

Lenders
When a lender is involved in financing a construction project, they setup the escrow account for managing the construction project and releasing funds as the construction progresses.
The borrower of such funds, depending on the state in the USA, may or may not have to pay interest on the whole amount of the loan. For example if the construction loan is for $2,000,000, the appraisal on the property, in order to justify the lender providing a loan for $2M, is based on the completed value of the property under construction. In addition, the borrower may only pay interest on the loan for the amount of each disbursement and based on the completed phase of the project. i.e. if the first disbursement is for $200,000, the interest is based on the funding of the first $200,000 as of a certain effective date. Next disbursement can be 2 months later, and the accruing interest on the next disbursement can start on a different date. So, the completion of each phase of the project is also tied in with the starting date of the next phase and when interest starts accruing for the following phase. As a side note, the parent company of i-Lien Software, Golden Omega also specializes in software for the mortgage industry. https://www.i-lie.net. Use the i-Lien Software to Create Joint Check Agreements.

Every construction project requires a steady flow of funds to ensure all parties have sufficient capital for their processes. Construction escrow accounts are among the most popular tools used by developers, contractors, and other top-tier parties to ensure fair and timely distribution of funds at every phase.

Use Joint Checks, in order to insure payments made to sub-contractors are guaranteed with it.
However, payments can be delayed due to the slow pace of payment processes from escrow companies or other third parties managing the transactions. So, make sure you double down on the protection by issuing a Preliminary Notice to the Owner, in order to establish your lien rights.
Using the i-Lien software, You can prepare a Preliminary Notice to Owner following your state’s construction laws to accelerate to protect your income. In regards to an Escrow Agreement, if you don’t have a lender involved, you can contact us and we can provide you with one to use. It is the same one included in our mortgage software for construction loans.

So, get in touch immediately with our team and explore what our innovative Mechanic’s Lien solution offers.