Most draw inspection problems fall into recognizable patterns. The specific details differ by project and borrower, but the underlying red flags, the conditions that indicate overfunding risk, potential fraud, or a project heading toward a cost-to-complete problem, appear repeatedly across construction loan portfolios. Lenders who know what to look for can catch these problems before they become defaults.
This article covers five draw inspection red flags that every lender should recognize, what each one typically indicates, and what action is appropriate when they appear.
Red Flag 1: Draw Request Progress That Outpaces the Site
The most direct indicator of overfunding risk is a draw request that claims more progress than the field inspection supports. When an inspector walks a project and finds framing at 55% complete, mechanical rough-in barely started, and a borrower claiming 75% complete on both, the gap is not a rounding difference, it is a material discrepancy that requires explanation before funds are released.
This pattern occurs for several reasons. Some borrowers front-load their draw requests as a cash flow strategy, requesting funds for work that is underway but not yet complete. Others make honest mistakes in their percentage estimates. And some are making deliberate misrepresentations.
The appropriate response is the same regardless of the cause: the disbursement should reflect the verified progress, not the claimed progress. The inspector’s recommendation should document the discrepancy specifically, which line items were overstated, by how much, and what the supported disbursement amount is.
Repeated overstating of draw requests across multiple draws, even if the amounts are modest each time, is a pattern that warrants heightened scrutiny and a conversation with the borrower. A borrower who consistently claims more progress than the inspector observes is either making systematic errors that suggest inadequate project controls, or is testing whether the lender’s monitoring will catch the discrepancy.
Red Flag 2: Stored Materials Claims Without Materials on Site
Construction loan draw requests frequently include claims for stored materials, materials that have been purchased and are on the project site but have not yet been installed. Stored materials claims are legitimate when the materials are actually present. They are a fraud indicator when they are not.
An inspector who walks a framing-phase project and finds a draw request claiming $85,000 in stored materials for windows that are not on site should document the absence and recommend withholding the stored materials portion of the draw. Materials that have been ordered but not delivered are not stored materials, they are accounts payable.
The most aggressive version of this fraud involves claims for materials that were never ordered, fabricated claims designed to extract cash from the loan before the project has reached the phase where the materials would be needed. Projects that claim stored materials for finish items, flooring, cabinetry, appliances, while still in the framing phase deserve particular scrutiny.
When stored materials are claimed, the inspector should confirm physical presence on site, assess that the materials are in acceptable condition and protected from weather, and verify that the quantities claimed are consistent with the project scope. A stored materials claim that cannot be physically verified should not be funded.
Red Flag 3: An Inactive Site at Draw Time
An active construction project has workers, equipment, and visible signs of ongoing work. A site that is consistently inactive at draw time, no workers present, no equipment operating, materials weathering without protection, is a red flag regardless of what the draw request claims.
Project inactivity can indicate several problems. The GC may have demobilized due to payment disputes with subcontractors, which often means the GC has been receiving draws from the lender but not paying the parties who performed the work. The project may be experiencing financial distress that has not yet been disclosed to the lender. Or the project may have effectively stopped, with the borrower continuing to submit draw requests for work that is not advancing.
When an inspector consistently finds an inactive site, the lender should request an explanation from the borrower before releasing any further draws. A project that was active at the prior inspection and inactive at the current one may be experiencing a temporary disruption. A project that has been inactive for multiple inspection cycles is exhibiting a pattern that warrants serious concern about the project’s financial health and the remaining loan’s adequacy.
Red Flag 4: Schedule Slippage That Threatens Cost-to-Complete
Every construction project has a budget and a schedule. The two are related: a project that is significantly behind schedule is consuming overhead and financing costs for longer than anticipated, which affects the cost to complete. More directly, a project behind schedule has often encountered the conditions, contractor performance problems, unforeseen conditions, design changes, that drive cost overruns.
Inspectors track schedule performance across draw cycles. When a project that should be 60% complete at month six is actually at 40%, the schedule slippage has cost implications that should be reflected in the cost-to-complete analysis. The question the lender needs answered is whether the remaining loan balance is sufficient to complete a project that is now running four months behind schedule and may be encountering the conditions that caused the slippage.
A cost-to-complete analysis that takes schedule slippage into account, that reflects current productivity rates and the cost of additional time rather than the original schedule’s assumptions, gives the lender an accurate picture of their remaining exposure. A cost-to-complete analysis that extrapolates from the original budget without accounting for slippage is not providing useful information.
When schedule slippage is significant, lenders should require the borrower and GC to provide a recovery schedule, a specific plan for getting the project back on track, before releasing the next draw. A recovery schedule that is vague or unrealistic is itself a red flag.
Red Flag 5: Missing or Deficient Lien Waivers
Lien waivers are the mechanism through which subcontractors and material suppliers release their lien rights in exchange for payment. When a general contractor receives a draw from the lender and does not pay subcontractors, those subcontractors retain their lien rights, and their liens can take priority over the lender’s deed of trust in ways that create serious title problems.
A draw inspection that reveals missing or deficient lien waivers, conditional lien waivers that have not been followed by unconditional releases for prior draws, or major subcontractors whose waivers are absent entirely, indicates that the prior draws may not have been properly distributed. The GC may be using construction loan draws to fund obligations on other projects, leaving the subcontractors on this project unpaid.
The appropriate response is to withhold the current draw until the lien waiver situation is resolved, specifically, until the lender has documentation confirming that the parties who performed work in prior periods have been paid and have released their lien rights. Funding a subsequent draw without resolving a lien waiver deficiency compounds the risk with each disbursement.
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Related: Construction Loan Monitoring · What Is a Draw Inspection · Draw Inspection Checklist · Construction Loan Monitoring Guide
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