What to Know About Land Loans
Are you planning to buy a plot of land to build a new home? Are you investigating a land loan?
If you need financing, you may find it more challenging to get a loan for land from traditional lenders.
Land loans are a more specialized finance product available from fewer lenders.
When purchasing land, there is often a more significant down payment requirement than buying a home.
So, it’s doubtful you can put down a minimal amount of money with a land purchase loan.
Quite often, with financing for land, there will be a higher interest rate and less time to repay the loan than you will experience with a house.
These are essential considerations to know when moving forward. Learning the ins and outs is vital if you decide to apply for financing for land.
Loans for land are far less commonplace than mortgage financing for a home.
Given this, it can be more challenging to get a land loan. There are far fewer lenders that provide loans for buying land than houses.
Let’s review the options if you need help purchasing land.
What is a Land Loan?
Loans for land are often called lot loans or land mortgages. They are used to finance a plot of land that may or may not be buildable.
You can get land loans when you’re interested in building a home or using it for a business. The type of loan on land will be dependent on where and how you plan to use the property.
Quite often, potential buyers confuse land loans with construction loans. They are different from one another.
Usually, construction loans are utilized when you plan on starting your home-building project immediately.
Land loans are better suited for those with extended plans to construct a home or business.
For example, a land loan would be a better option if you plan on building a home a year or two from now.
How Do Land Loans Work?
Many potential property owners ask, “How do loans for land work”?
Lot loans are similar to getting a mortgage on a house. The difference is that the land is more challenging to value because no home is constructed for collateral.
Given this, loans on land are riskier transactions for land lenders. To compensate, you’ll find that land loans have higher down payment requirements and interest rates than home mortgages.
There are several types of loans on land, and each has its qualifications. As a general rule, you can expect that with financing for land, you need to have excellent credit scores of more than 720.
Land lenders will also ask borrowers to explain how they intend to use the plot.
Land loan lenders will also ask for additional information, such as a land survey showing zoning, boundary lines, access to utilities, and any restrictions, such as wetlands.
Lenders will analyze the investment project and, based on their determinations, will issue a loan commitment.
Make Sure to Vet The Builder
Building a new home from scratch is more daunting than many people realize. The inherent challenges can lead to more people giving up on their dream of building their own homes and ending in foreclosure on the land.
These risks are why land lenders frequently need more substantial down payments and shorter repayment timescales on a land mortgage.
Higher interest rates can also be expected over a standard home mortgage.
If your land loan will be for a short time, and you plan on hiring a contractor, don’t forget how critical it is to vet the builder.
When purchasing new construction, there are many questions you should ask a builder to ensure you have a pleasurable experience.
As you might imagine, there are many horror stories of buyers and the builders they choose to work with.
Different Types of Loans For Buying Land
A loan for land purchase can have different variations. Let’s review the land mortgage options.
Raw Loan For Land
Land can come in many, many different variations. Raw land is when nothing has been done to it. It is typically virgin soil with no roads, sewer systems, or public utilities.
You’ll need a raw land loan when you’re interested in buying this type of land. Getting a loan for land in this state is far more complex.
This type of raw property loan is typically reserved for developers with experience building subdivisions or some business purpose. Builders will buy a parcel of land to build residential construction.
When choosing a raw land loan, it will be vital to put together a comprehensive plan to show the lender exactly what you intend to do. Land loan lenders will want to feel confident they will be lending on a project that will be successful.
You must have a substantial down payment and a good credit history to get this kind of mortgage loan. Lenders want to minimize their risk in lending, and this is how they do it. It will be vital to have a good credit score.
Buying raw land is less expensive than buying developed land, but there will be higher interest rates.
When taking a loan application for a vacant parcel of land, land loan lenders typically require a detailed plan as part of the approval process.
Unimproved Loan For Land
An unimproved land loan is like a raw land mortgage, but the land is slightly more developed. With this type of loan, you will typically see some utilities installed at the property, usually on the street.
These loans for a property are similar regarding what the bank or credit union will be looking for in terms of financial stability from the borrower. Having excellent credit is a must.
Like a raw land loan, you will want to have a set of detailed drawings of what you would like to do with the property. Don’t expect lower rates just because some utilities are on the street.
Undeveloped land always carries higher interest rates. Higher interest rates are the norm with all types of land loans.
Improved Loan For Land
Given the lower lending risk, an improved land loan is ideal for lenders. Improved land mortgages are for vacant land with nearby improvements, such as roads, water, electricity, and other utilities.
Land ready for development by a builder or homeowner is much more expensive. The purchase price will be significantly higher than undeveloped land.
Given that there is less risk with an improved property loan, you can expect interest rates to be slightly better and possibly more relaxed down payment requirements. This mortgage loan is still risky for a lender because there is no collateral like there would be with a house purchase.
Those who get this type of loan sometimes end up with a traditional mortgage for their primary residence, which they typically intend on custom building.
Buyers who utilize land loan financing are often not interested in purchasing cookie-cutter housing. Instead, they want to build their dream home with significant custom features.
This type of mortgage for land is the most common.
A vacant lot ready to build in many parts of the country is challenging to find and often can be very expensive.
How to Get a Land Loan?
You’ll want to investigate a few things before buying a piece of land or building lot.
Understanding what to know about buying land is critical. Going in blind on a loan for land is a significant mistake.
Before pursuing loans for land, you’ll need to research the following:
- You will need to have the land surveyed to get land financing.
- The property lines should be marked, and research should be done to ensure no encroachments from other adjacent landowners.
- The land will need to be considered buildable in most cases.
- Checking land use and zoning restrictions is critical.
- The more improved the land is, the easier it will be to get a loan – from buildable to unimproved to raw land.
- Research whether the lot is serviced publicly or privately (city sewer vs. septic system).
- Does municipal water service the land, or do you need a private well installed?
- Ensure there is access to utilities and public roads.
- Ensure to investigate whether any easements encumber the land, especially those that affect usability.
- Investigate whether there are any conservation issues.
- Research whether there are any property liens, both recorded and unrecorded.
- Ensure that a title search is done and that it is feasible to get title insurance to protect your investment.
Each item on the checklist is essential when getting a land loan.
Types of Land Loans
You may encounter a few different types of land loans when you finance your building plot. The advice for choosing a lender when buying a home is similar to when purchasing land.
Do your homework, look at reviews, and you might even consult a local real estate agent working with new builds. As previously mentioned, land mortgages are far less common, so they require more research on your part.
You will make monthly payments with loans to buy land just like you would with other mortgage loans.
1. Construction to Permanent Loans
A common way of financing land purchase, when you know precisely what you will build, is a construction to permanent end loan. This loan gives you the money to purchase the land and build a house, all rolled into one mortgage.
You will provide construction plans to the lender and other project details. Your building plans need detailed blueprints, not an 8×11 sketch. You’ll also need to give the cost of building the house and exact specifications.
In the early stages of the loan, you’ll only be paying the interest on the land price.
Once construction on the home begins, you” are given what’s known as “draws” from the bank to pay for construction phases as the house is built.
For example, you may receive a draw when you dig the foundation’s hole and then install the same. A draw would then be given when the house is framed, and so on, until the project is completed.
The lender keeps tabs on the money going out for its specific purpose during construction by providing draws. A bank member or a hired third party often inspects these phases.
The lender wants to ensure the money will construct the property, not something else.
When the construction is done, it will convert to a regular mortgage. The mortgage terms you receive are usually similar to end loans on resale home purchases.
If you are buying land and building a home right away, a construction to permanent loan is an excellent option.Click To Tweet2. FHA Construction to Permanent Loan
FHA also has a construction-to-permanent loan option. With this land purchasing option, you must start your home construction project immediately.
You will have draws just like in the scenario mentioned above. The difference here is that HUD will back the loan.
The potential advantage of an FHA construction loan is that they have low down payment options. You might be able to put down as little as 3.5% for the entire construction-to-permanent loan.
While it’s true that FHA home loans typically have looser buyer eligibility requirements, such as a lower down payment requirement, they may require more with construction loans.
It is not unusual for many lenders to require at least ten percent down. Before meeting with a lender, it would help to research this upfront.
Borrowers with a credit score between 500 and 570 must put at least ten percent down. If your score is above 580, you might have a shot at getting away with only 3.5% down.
When getting a loan for land or a home, getting a copy of your credit report and checking for errors is always advisable. A mistake could impact your ability to get the best loan terms.
Remember that a lender for land loans has eligibility requirements, so their standards can be higher than HUD.
3. USDA Land Loans
The USDA has Section 523 loans to buy the land and Section 524 loans to pay for the building.
A USDA land mortgage could be an option if you meet their lower-income criteria, and they also provide low interest rates.
The downside is that the loans must be repaid in only two years.
Section 523 loans work for borrowers who want to build their own house, while Section 524 allows you to hire a contractor to build a home for you.
Both loans are designed for low to moderate-income families.
Remember the qualifications for buying land and building in what’s considered rural. There will be population limits with this type of financing.
One of the best things about a land loan with USDA is that you are not required to put any money down.
It is one the only no down payment land loans.
4. Standard Lender Loans
A land-only loan is the best option when buying property and not starting construction on a home for extended periods.
Larger lenders may not help you, but local credit unions or community banks could be the answer. They will better understand your area’s market and be more likely to provide the money you need. These are the most common types of land loans.
If you are determined to build quickly on the plot of land, this could allow you better interest rates and longer loan terms.
If you don’t want to build on the land immediately, you could need a much larger down payment; up to 50 percent wouldn’t be unusual.
Many lenders will require a minimum of 30 percent down for a loan on land.
5. Home Equity Loans
One of the more unconventional ways to get a loan for land purchase is tapping your home’s equity. You would do this via a home equity loan. If you already have a home, you could use your property’s equity to buy the land.
Doing so could give you the money you need with less interest and no down payment. The downside is that your home is at risk if you fail to keep up with the payment plan.
Your interest is not tax-deductible because the loan isn’t used to buy, build, or substantially improve your home. The standard repayment of these loans is between five and thirty years.
A home equity line of credit may be suitable for folks who don’t want to establish relationships with a different lending institution.
Although some people do it, a home equity loan is probably not the best option for financing land.
6. SBA Loans
The Small Business Administration could help if you are a business owner. This government agency and a lender of your choice will partly finance their 504 loan program.
You must find 10 percent of the purchase cost, with the SBA covering 40 percent and the lender’s remaining balance.
The repayment period can be between 10 and 20 years at the current interest rates. The exact terms are dependent on the lender involved in the loan. These kinds of loans are often used when someone is doing a commercial building project.
7. Seller Land Loan Financing
Getting finance for the land from the business or person you buy it from can be possible. If you are lucky enough to have this as an option, you can expect to need a big down payment, and the interest is unlikely to be competitive.
If a seller is willing to finance the land purchase, they are probably interested in making it worthwhile. That means making money at a higher interest rate than what you would expect to pay from a traditional land lender.
A loan on land from the owner will probably be one of your more expensive options.
Calculator For Land Loans
Are you interested in having a good idea of what your payments will be with your loan?
Use this land loan calculator to determine your monthly payments and total interest paid based on your interest rate, down payment, and loan length.
What is The Interest Rate For Land Loans?
Like home loans, the interest rates for a land loan fluctuate constantly. You will need to check with land loan lenders for the current interest rates for land.
Loan for land rates is currently in the mid-5 percent range.
Interest Rates and Down Payment Requirements
In obtaining a loan, it’s crucial to understand the significance of interest rates and down payment requirements. These factors are critical in determining the overall cost of financing and the financial commitment you must make.
Understanding Land Loan Interest Rates
Land mortgage interest rates can vary based on several factors, including the lender, loan term, and creditworthiness. Generally, interest rates for land loans tend to be higher than traditional mortgages. This is because land loans are considered higher-risk investments for lenders.
Reviewing and comparing offers from different lenders is essential when assessing interest rates. Consider obtaining multiple quotes to secure the most competitive interest rate possible.
Factors Affecting Land Loan Interest Rates
Several factors can influence the interest rates on property loans. These factors include:
- Credit Score: A higher credit score typically leads to more favorable interest rates.
- Loan Amount: Larger loan amounts may have lower interest rates.
- Loan Term: Longer loan terms may result in higher interest rates.
- Down Payment: A larger down payment can help lower interest rates.
- Property Type: The intended use of the land can impact interest rates.
Understanding these factors can help you determine how they might affect the interest rate you’re offered. Exploring options and choosing the most suitable lender and loan terms is crucial.
Down Payment Requirements for Land Loans
When applying for a land loan, you’ll need to consider the down payment requirements set by lenders. Down payment requirements for lot loans can vary depending on the lender’s policies, loan type, and creditworthiness.
Typically, lenders require a higher down payment percentage for land loans than traditional mortgages. The down payment requirement could range from 20% to 50% of the land’s purchase price. Your down payment amount will impact your loan-to-value (LTV) ratio, a significant factor in securing favorable loan terms.
Ensure you understand the lender’s down payment requirements and factor this into your financial planning when considering a land mortgage.
Saving for a larger down payment can help you secure better loan terms.
Finding a Lender For Land Loans
The best banks for a land loan are usually local lenders. It would be advisable to ask around for a financial institution that does a land purchase loan.
Asking a real estate agent or local builder might be helpful. Doing an online search might also be beneficial. I would suggest land loan lenders near me as a search option.
Some of the larger lenders for loans on the property include Guarantee Rate, Quicken Loans, PrimeLending, Axos Bank, New American Funding, Ally, and PNC Bank.
Use a Credit Union to Get Loans For Property
Your local credit union is one of the best places to try for a land purchase loan. Credit unions are usually not opposed to financing land purchases.
A credit union often offers lower interest rates than other lending institutions.
Credit unions are well known for giving lots of loans for individuals to build their dream homes eventually.
As mentioned, a local or community bank is another promising avenue to try. These lenders often go out of their way to give a mortgage loan for business or individual use.
Local and community banks are the primary lenders you should try first. You will often get more favorable terms than other land loan lenders.
If the land is not expensive, you might also get a personal loan with a credit union.
Use Farm Credit
If you are a farmer looking to get a land purchase loan, you might want to use Farm Credit, a network of 71 customer-owned financial institutions.
They provide loans for buying land to U.S. farmers, ranchers, and rural homebuyers in all fifty states and Puerto Rico. You can get more information on their website.
The Land Loan Application Process
The land loan application process involves several steps to ensure eligibility, and gather required documentation. It is essential to understand the process to navigate it successfully.
Eligibility Requirements for Land Loans
Before applying for a land loan, it is crucial to meet the eligibility requirements set by the lender. These requirements may vary among lenders but commonly include:
- A minimum credit score, typically above 620
- A stable employment history
- A debt-to-income ratio within an acceptable range
- Sufficient income to cover loan payments
Meeting these eligibility requirements increases the chances of approval.
Gathering Documentation for a Land Loan
When applying for land financing, it is necessary to gather certain documents to support the application. These may include:
- Proof of income, such as tax returns and pay stubs
- Bank statements to verify financial stability
- Proof of identity, such as a valid driver’s license or passport
- Property information, including surveys, appraisals, and legal descriptions
Gathering and organizing these documents before applying for a lot loan streamlines the process and demonstrates preparedness to the lender.
Pros and Cons of Land Loans
Pros of Obtaining a Land Loan
Obtaining a property loan provides several advantages for individuals looking to secure property for future use:
- Opportunity for Future Development: Investing in land allows for potential future development, such as building a home or establishing a business.
- Asset Appreciation: Land has the potential to appreciate over time, offering the opportunity for a profitable investment.
- Flexibility in Use: Land loans provide the flexibility to use the property for various purposes, including residential or commercial use.
- Access to Desirable Locations: A land loan grants the ability to acquire property in desirable locations, such as scenic areas or thriving neighborhoods.
- Tax Advantages: Land ownership may provide certain tax benefits, such as deductions for property taxes or mortgage interest.
Cons and Risks of Land Loans
While land loans have their advantages, it’s crucial to consider the potential drawbacks and risks involved:
- Higher Interest Rates: Land loans typically come with higher interest rates than traditional home mortgages, increasing the overall cost of borrowing.
- Down Payment Requirements: As mentioned, property loans often require larger down payments, making it necessary to have substantial funds available upfront.
- Difficulty in Securing Financing: Lenders may have stricter qualification criteria for land loans, making it more challenging to obtain financing.
- Market Volatility: Land values can fluctuate depending on market conditions, potentially affecting the investment’s profitability.
- Development Challenges: Land development can involve additional costs and complexities, such as obtaining permits and utilities.
- Limited Income Generation: Unlike rental properties, vacant land generally does not generate immediate income, potentially impacting cash flow.
Understanding the advantages and disadvantages of land loans is crucial in making an informed decision before pursuing financing for land acquisition.
FAQs With Land Loans
These are some of the most frequently asked questions when getting a land purchase loan, along with their answers:
1. Is it Hard to Get a Loan to Buy land?
Getting a loan for land is more challenging due to the stringent down payment and credit score requirements. Fewer lenders also offer these loans.
2. What is The Longest Land Loan You Can Get?
The loan term for lot loans is usually two to five years.
3. How Much Do You Have to Put Down With Land Loans?
You need between ten to thirty percent down when purchasing a buildable lot. The requirement will depend on the loan program.
The down payment requirement can be as much as 30 to 50 percent down when you buy raw land.
4. Which Loan is Best For a Land Purchase?
The best loan for land purchase is one of the discussed options: seller financing or an equity loan if you own a home.
5. Can I Get a Land Loan With Bad Credit?
It can be far more challenging, like buying a home with bad credit. You must be at least twenty-one years old and show you are gainfully employed with a steady income.
The amount you can borrow will depend on the value of the land. Given that it is a bad credit land loan, you will need a 40 to 60 percent down payment.
6. Who Does The Most Financing For Land?
Surprisingly, most property loans are written by local lenders vs. large lending institutions. Credit unions and community banks are good sources of finding land loans.
7. Will a Lender Take Land as Collateral?
Finding lenders that take the land as collateral is hard, but it is not impossible. Lenders who take the land as collateral will want it to be worth a designated amount. You’ll also need to be the landowner with the title in hand.
8. Can Land Be Used as a Down Payment?
Yes, if you get a construction loan to buy land and build a home simultaneously.
9. Is Land a Good Investment?
Yes. They aren’t making any more land, are they? If you purchase land that can be developed, it can offer tremendous long-term gains.
In some areas of the country, the value of land has skyrocketed. Rarely do land values go down!
Understand The Land You’re Buying
While working as a real estate agent over the past thirty-five-plus years, I’ve realized that most people are uneducated about buying land.
A significant amount of research and considerations need to be analyzed.
It would be best if you had a strong understanding of what to look for when buying land.
For example, does the land have a sewer hook-up or need a septic system installed? If it is the latter, the land expense can be substantial.
Septic systems are not cheap, and the costs of installing one are highly variable. Several things can significantly impact the costs, including the water table’s height and the existing soil.
Septic systems are built according to these things. If you have a high water table, additional fill, and soil must be brought in.
If the existing soils are rocky, clay, etc., they must be replaced with gravel.
What about any ledge on the property? Yes, that can be a substantial stumbling block.
You could spend thousands of additional dollars blasting for a septic system or the foundation hole for your home to be built.
How about wetlands on the lot? Wetlands are another thing that should be considered when buying land.
What will the local building department require from you? Typically, when wetlands are involved, you’ll need to follow strict guidelines on what can be done within a specified distance of the wetland.
Understand Land Conservation Requirements
Additionally, you may be required to do other things, such as putting up a silt fence. Local municipalities will issue an order of conditions that must be followed. The order must be adhered to and cleared before you can get a clear title.
Land buyers should also know that “wetlands” does not necessarily mean a body of water. Wetlands are classified based on vegetation.
Investigating whether there are any conservation issues should always be a prime consideration when purchasing land.
Lastly, does public water service the land, or will a private well be installed? Having a municipal water source makes things easy.
If you need to install a well, it can be expensive. You can expect to pay between five thousand to ten thousand dollars for an artesian well installation and possibly more. The well must also pass testing for quality and quantity standards.
The local board of health will regulate these tests. Without passing, it is doubtful you will get a building permit.
These things must be considered before getting a land loan to build a home. Having a sewer connection will take some of these worries away.
Buying a lot that does not have a sewer connection or an approved septic design is NEVER advisable. Without these things, you could be purchasing a worthless plot of land.
Indeed, it can’t be built on. Never get a land loan without knowing with one hundred percent certainty the property is buildable.
The Right Land Loan For You
Investigate all your options before committing to a loan for whatever you want the land. Planning for land usage before looking for a mortgage would be best. This will allow you to apply for the right loan and show lenders that you are less risky.
You also need to understand what loan terms are best for you. For example, will you pay off the loan quickly, or is a more extended period required?
Buying land to build the home of your dreams is a big project, but having the right financing in place should make things a little easier. Due diligence is just as critical as buying a home and sometimes even more so when it’s land.
Hopefully, you now understand what you should know about buying land and getting a loan. There are many financing options, so researching which is best for you is worth exploring.
About the Author: The above Real Estate information about what is a land loan was provided by Bill Gassett, a Nationally recognized leader in his field. Bill has expertise in mortgages, financing, moving, home improvement, and general real estate.
Learn more about Bill Gassett and the publications he has been featured in. Bill can be reached via email at billgassett@remaxexec.com or by phone at 508-625-0191. Bill has helped people move in and out of Metrowest towns for the last 37+ years.
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