Understanding Land Loans
It’s unlikely that a conventional mortgage creditor would lend you the money to buy a plot of land on which to build a home or put up a business.
If you wish to acquire the land entirely, you will probably have to make do with a land lease or apply for a land loan. However, land loans are not nearly as widespread as conventional mortgage loans, which means that there are fewer choices available.
Because there is less competition among creditors, you may be required to put down a more immense amount of money, pay a higher interest rate, and have a shorter repayment period than you would with a conventional mortgage.
When applying for a land loan, it is essential to have a thorough understanding of the financial commitment you will be making as well as the ways in which you may cut your expenses.
What Is a Land Loan?
The acquisition of a piece of land can be financed through the use of a land loan, which is also frequently referenced to as a lot loan.
If you need money to acquire land for residential or commercial development, you can apply for a land loan. The location and intended use of the land you purchase will determine the sort of mortgage you apply for.
One of the most common loans taken out by homeowners in order to build their dream homes is a construction loan, but many people don’t realize that a land loan is a distinct financial product. What then is the distinction?
Construction loans are commonly needed when purchasing land with the intent of immediately constructing it. Homeowners that have everything planned out and are ready to start building can benefit from these short-term loans.
However, prospective home builders who already have a plan but aren’t quite ready to build and finance a house just yet may benefit from taking out a land or lot loan instead.
If you anticipate that your construction project will take more than a year to complete due to unforeseen reasons (or if you are still in the process of putting together your house designs), a loan secured against the land might be a more suitable option for you.
How Do Land Loans Work?
A land loan is very much like a regular mortgage in terms of how it operates. A creditor may grant you this form of loan so that you may acquire the land of your choice. After that, you are going to repay them, together with interest, throughout the course of the subsequent years or decades.
However, in order to qualify for a land loan, you may have to demonstrate a higher level of financial responsibility than you would when applying for a conventional mortgage. Thus, applicants may be required to demonstrate a high credit rating (700 or more) and provide an explanation of the land’s intended purpose.
Debtors may also note things about the property, such as zoning, land use limitations, surveyed boundaries, and utility availability, that need to be verified. Creditors can gauge the potential risk of the loan based on these considerations.
How to Get a Land Loan
You may want to look into more than one creditor if you require a land loan.
Large national creditors and online creditors may be less receptive to financing land than their local counterparts because they lack in-depth familiarity with the area that is required to determine whether or not making a loan on a certain piece of land is a dangerous proposition.
When looking for a land loan, community, and regional financial institutions are usually your best bet. Working with a local usually indicates you’re dealing with an expert in the field.
An application for a land loan will include details about your employment, income, debt, and assets. To reduce their risk, creditors will look for solid guarantees that you won’t default on your loan.
Creditors like applicants who have a solid credit history and a debt-to-income ratio that is lower than what is typically required for a mortgage. In addition, creditors favor applicants who have a high amount of available income.
It’s possible that the application for a land loan will ask you to give more specific information than the application for a mortgage would. It is much simpler to obtain a mortgage once the house has been built and the intended use of the land has been established.
Different Types of Land Loans
The following are the most typical types of land loans:
- Raw Land Loan – A piece of property that has not been developed in any way, including not having any electricity, roads, or sewerage, is referred to as “raw land.”
It can be challenging to obtain funding for land that has not yet been developed; therefore, it is essential that you prepare a solid and clear strategy for how you intend to improve the land. Creditors will view you as less of a risk if you can demonstrate that you are dedicated to the project through actions such as these.
Your chances of being accepted into the program will improve if you have good credit and make a substantial down payment (usually at least 20% of the total loan amount).
Although the acquisition cost of raw land may be lower than that of developed land, the interest rates on loans for raw land are typically higher, and larger down payments are typically required, in comparison to the requirements for loans for other types of land.
- Unimproved Land Loan – Raw land and unimproved land are essentially the same thing, however unimproved land has typically undergone some level of development. Unimproved land may or may not have some facilities and amenities, but it almost never has a phone box, an electric meter, or a natural gas meter.
Even though an unimproved land loan carries a lower level of risk than a raw land loan, acquiring one can still be challenging; therefore, you should ensure that you have a comprehensive strategy, a sizeable down payment (at least 20% of the purchase price), and an excellent credit rating.
Unimproved land loans aren’t the riskiest kind of loans, so there won’t be outrageous down payments or interest rates, but it’s typical for them to be greater than with other loan funding.
- Improved Land Loan – Unlike undeveloped or raw property, improved land has infrastructure like roads, electricity, and water already in place. There may be a premium to pay for improved land because of its higher level of development.
As opposed to raw land loans or unimproved land loans, improved land loans have more favorable terms, including lower interest rates and smaller down payments. Even so, it’s critical to have excellent credit and save up for a sizable down payment.
Buyers can get land and lot loans in the same way they can get mortgage loans for houses, but unlike with a house, it’s not always easy to put a price on the land since there is no physical asset to use as security.
As a result, creditors require more of a down payment and charge higher interest rates on land loans than they would for a conventional mortgage.
Land Loans: Pros and Cons
While some people may benefit from a land loan, the vast majority of homebuyers will not. For what it’s worth, here are some scenarios in which you might benefit from them and some in which you probably won’t:
Pros
- Financing your own home construction is easy if you’re purchasing a vacant lot.
- Instead of purchasing an already-built house, investing in land gives you the option to design and construct a house from the ground up.
- If you go with the option of a raw land loan, you will have the option to keep the property in your possession for a certain period of time until you are ready to begin the building process.
- It can assist enterprises in establishing themselves in a new area.
Cons
- In a slowing economy, purchasing land may be more of a gamble than purchasing a home.
- You may have to spend more time looking for a reputable creditor that offers land loans.
- If you’re buying raw land with the intent of building on it, you’ll want to make sure the land is suitable for a house.
- There will probably be stricter requirements for both your credit rating and your down payment amount.
Alternatives to Land Loans
If you want to buy land but are hesitant to get a land loan, these alternatives could be the best solution for you.
- Home Equity Loans – In this case, you may leverage the equity in your current home to get a loan for the land. When your equity (the value of your property less the balance of your mortgage) is more than 20%, you may get a loan against it.
Therefore, if you have equity in your house equal to 35% of its worth, you will have the ability to loan against 15% of the value of your house. Since properties can be quickly resold if the debtor defaults, home equity loans often have cheaper interest rates than land loans.
- Seller Financing – It’s possible that the present landowner will offer financing options to interested buyers. Here, the seller determines the parameters of the loan and the prerequisites you must complete to close on the sale of the property.
You should consult with a real estate attorney before moving forward with seller financing. Payments will be made to the seller directly upon the closing of the agreement unless the seller has sold the promissory note to an investor.
Bottom Line
Obtaining loans for the land on which to construct your dream house is a far more involved process than securing a conventional mortgage.
Loan providers call for surveyed property borders, and you should examine any limits on building or farming, as well as the availability of public services and transportation routes. If the land has already been developed, you might anticipate a cheaper initial payment and cheaper interest rates.
Furthermore, if you’re thinking of constructing a house, you must carefully contemplate the perks and downsides of a land loan.
