Cost-additive change orders first draw on the contingency reserve in the loan budget. Once contingency is exhausted, the standard loan document requires the sponsor to fund the overrun with new equity (the balancing test) before the lender will fund any further draws. A material change order may also require lender consent, architect re-certification, and updated cost-to-complete projections.
Three layers of change-order absorption
Layer 1, contingency reserve. Almost every institutional construction loan budget contains a contingency line of 5% to 10% of hard costs (sometimes 3% on heavily-permitted institutional product, 10%+ on adaptive reuse or complex sites). Cost-additive change orders draw on contingency first.
Layer 2, sponsor balancing. Once contingency is exhausted, the loan documents typically require the sponsor to fund overruns with new equity before the lender funds the next draw. This is the balancing test: the lender will not fund more than its proportional share of remaining work.
Layer 3, re-sizing or workout. If the projected cost-to-complete materially exceeds the loan budget plus available equity, the deal needs a re-sizing, increased loan, additional mezz, or a recapitalization. This is the worst layer to land in because it converts a construction project into a workout discussion mid-build.
Practical management: the placement firm and the GC's PM should track contingency burn against percent complete on a monthly basis. Burning contingency faster than the build is a leading indicator of a budget problem; flagging it early gives the sponsor time to negotiate scope reductions or value-engineer before the lender's monthly draw inspection forces the conversation.
Sources
- Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations · Mortgage Bankers Association · 2026-Q1
- Semiannual Risk Perspective · Office of the Comptroller of the Currency · 2025-12
- Financial Stability Report · Board of Governors of the Federal Reserve System · 2025-11