While it can be a surprise to someone seeking construction financing for the first time, it certainly is not a revelation for any builders, developers, or property owners that have done any type of construction in the past where third party debt financing is required.
For someone new to construction financing, it seems logical that if you can qualify for a construction loan with a bank or institutional lender, then that would be the right place to acquire your construction capital from.
But the reality is that while a conventional lender can provide funding at a lower cost than a private lender, the terms and conditions of financing can be very difficult to comply with at times, and if there are delays in meeting certain terms and conditions, there may not be any cost saving at all once you factor in the other costs incurred due to delays or the incremental third party support requirements of the lender.
To start with, most banks will not finance construction on a single family build unless they also get the long term take out mortgage as well. So while you may be able to get a construction loan at a great rate, you may not be able to secure the best market rate for the long term financing, which in the long run can cost you more money overall.
The next challenge can come in the application process. Banks and institutional lenders are low rate and low risk financing sources, so they can require a considerable amount of documentation and third party verification before they are prepared to issue a commitment. There are times when a construction loan application with a private lender will only take a fraction of the time which can be incredibly important to the project if the start time is imminent.
Perhaps the greatest challenge and risk associated with conventional construction mortgages is the draw advance schedule. Most times the lender will require a third party appraiser to assess the amount of completion at a draw stage. Even when you are completely on track with your plan, the appraiser can still insist that you will require incremental funds to complete the project and cut back on draw amounts to make sure you have enough funds from the lender to complete the rest of the project. While draw delays and reductions can still occur with a private money lender, they are much less common and provide a more predictable draw advance schedule to work from.
In the end, one can argue that the additional cost of a private mortgage for construction comes with several benefits that many builders, developers, and property owners are prepared to pay for.