Is
retainage legally required?
Yes.
The Property Code requires every owner of property subject to construction
or repair to retain during the progress of the work.
How
much and how long?
10%
of the cost of work or (if the project is not completed) 10% of the value
of the work. Retainage is to be held until 30 days after completion (excluding
maintenance and warranty work, but not excluding punch list items).
Why
don’t lenders require retainage on all construction loans?
Commercial
impracticality-it creates an administrative burden and usually, the borrower
and contractor desire to waive retainage. The owner not the lender, is required
to follow the law, and there is no statutory penalty for not retaining.
Is
it common for lenders to require retainage on commercial construction loans?
Yes,
unless the project has a payment bond. Usually, 10% of each draw is held in
a restricted account. Retainage is sometimes waived on smaller construction
and renovation projects, or where the borrower has substantial liquidity to
pay unpaid subs and suppliers.
What
about builder loans?
No.
If the builder is the borrower and the owner, each "sub" would have
a separate contract and separate retainage would be required for each. Builder
lending is too competitive to allow a lender to require retainage.
What
about residential interim (build on your lot) loans and one-times?
It
varies with lending institutions and how many times the lender has been "burned".
Sometimes lenders will waive the retainage requirement on the basis of underwriting
the builder and the liquidity of the consumer.
How
is retainage handled on residential interim and one-time loans?
Usually
retainage is a budgeted item and retainage funds are "reserved"
in the loan, rather than advanced with each draw. It is not clear whether
this meets the Property Code requirements, but it is a common practice.
What
about the practice of releasing retainage early?
It
is the custom on home construction lending to release retainage upon completion
without waiting the 30 days; this is because of the owner’s desire to
close on the permanent loan and the title company’s willingness to accept
the risk of unpaid mechanic’s liens in issuing its mortgagee policy.
Can
the customer contract to release the retainage early?
Yes.
Many home builders do not mind retainage being budgeted so long as it is released
when the house is completed. The builder wants the owner to agree in advance,
thus taking away the owner’s leverage to "renegotiate" the
contract by refusing to release the retainage. A document is signed at loan
closing whereby the borrower agrees that if the house is completed per appraisal
recertification and the title company is ready to insure, the retainage will
be released early without the borrower signing off.
What
are the alternatives to retainage?
Payment
bonds, as mentioned above. Lien releases at draw request, plus bills paid
affidavits. But subcontractor/supplier releases create a paperwork burden
on the lender.
What
is the worst case scenario for a lender who does not require retainage?
Unpaid
subs and suppliers file liens, the borrower cannot or will not pay. The lender
ends up paying the lien claimants, increasing the loan thereby killing the
takeout, or foreclosing on the property. The firm’s experience has been
that unpaid lien claimants are the most common and expensive form of construction
default. A good retainage policy properly followed greatly diminishes the
exposure of losses to lenders.