Most people are surprised to learn that the primary source of construction loan financing is actually from private lending sources.
Even though banks and institutional lenders are typically everyone’s first choice due to lower rates, there are a number of reasons why private mortgages can become a preferred choice both in terms of benefits and costs.
Let’s explore this further.
For single family homes, banks and institutional lenders will only extend construction loans if they can also secure the long term take out mortgage in the process.
This requires the borrower to apply and get approved for both types of mortgages prior to the advancement of the first construction draw.
And because the builder or property owner is only working with one bank, they are automatically limited with respect to their take out mortgage options.
Typical of any bank application process, there is a lot of paper work involved and it can take some time to get the construction financing and take out mortgages approved with funds available for disbursement.
Even when everything is ready to go, there can be challenges with getting draws completed on a timely basis and having draws reduced due to appraiser estimations of the remaining work.
So while on the surface, a bank or institutional lender can provide a prime plus type of interest rate, there are other potential costs to consider such as delay related costs if draws are not advanced when required, bridge financing costs if draws are cut back, up front due diligence costs, draw administration costs, and so on.
So partly due to an inability to quality for bank financing and partly due to time and complexity of a bank financing process, builders, developers,and property owners largely utilize private mortgages to fund their construction projects either as a primary or secondary choice.
Faster Application And Approval Process. For the most part, private mortgage lenders have a much more straightforward approach to construction financing which is can be contributed in a lot of cases to the fact that you are only dealing with a one person in most cases. The streamlined approach to lending from private lenders that specialize in construction can cut a significant amount of time off of the construction loan acquisition process.
More Predictable Draw Administration. Private lenders do not tend to have the same level of work completion verification that you can expect from a bank or institutional lender and in many cases they will do the construction phase inspections themselves. While its still possible to have a draw delay or a draw reduction from a private lender on a construction loan, that type of occurrence is going to be the exception more than the rule. This higher level of predictability of how money is going to be advanced can be considerable benefit to project management. And even though the cost of funds is higher, when you cut out many of the other required expenditures as well as any unplanned expenses you may incur due to bank construction loan, the overall effective rate of financing by the end of the project can be closer than what it may appear at the outset.
Greater Flexibility On Arranging A Take Out Mortgage. In those situations where a take out mortgage is required, private lenders do not always require that the take out mortgage be approved in advance of construction, providing you with more time and opportunity to get the best potential deal available to you in the market. Over the course of several years, this could lead to a substantial cost saving in some circumstances.
For commercial and industrial projects, banks and institutional lenders will provide one off construction financing on larger deals, but for smaller deals they may still require a tie in to the long term take out mortgage or make their funding being conditional on a long term mortgage being available to them.
For commercial or industrial construction projects under $2,000,000, private mortgage financing is still very popular and comes with similar benefits to what has been described for single family homes.
As the amount of construction mortgage financing increases beyond $2,000,000, there are going to be less private lenders available due to the size of the loan exposure and there will also be more syndication of the larger deals which will add more time and complexity to the deal.
There is a definite fit for private construction loans as there is for bank construction loans.
The best way to know what approach is going to be the best fit for your construction project and lending requirements it to work with a private mortgage broker that places construction loans in the area of the province you’re working in.
If you need construction loan financing for a project you’re planning or one you’re in the middle of right now, please give me a call so I can quickly assess your requirements, and provide construction loan financing options for your immediate consideration.