Land loans: what you need to know
If you look at a piece of land for to build a home on or to use for business purposes, you probably won’t be able to get a regular mortgage to finance the purchase. Instead, you will likely need to apply for a land loan.
However, home loans are not as common as traditional mortgages, so there are fewer options. With less competition among lenders, you could face a larger down payment requirement, a higher interest rate, and less time to pay off the loan than with a traditional mortgage. If you are applying for a land loan, it is important to know what you are getting into and how to reduce your costs.
What are land loans?
A land loan is used to finance the purchase of land. There are different types of mortgage loans depending on the type of property you want to buy:
- Earthen generally does not have access to public services and does not have improvements; it may not even be accessible by road. Raw land is generally cheaper than alternatives, but financing can be difficult.
- Unimproved land may have access to some utilities but still lack some improvements, such as a telephone line or a gas or electricity meter. It is easier to get financing for unimproved land than for raw land, but it can still be difficult.
- Improved terrain is developed with full access to utilities and the road. Although this is the most expensive type of land, it is the easiest to finance.
Land loans are only a very small part of the lending market and tend to be riskier for lenders than mortgages, says Casey Fleming, branch manager at Fairway Independent Mortgage Company in Campbell, California. If a lender has to foreclose on a land loan, there is no guarantee of getting the money back.
“Raw land owners are much more likely to stop paying and leave the property if there is a financial event in their life,” says Fleming. “If you own your own home, you will do all you can to save it. With raw land, you cannot use it or earn income from it.
Vacant land is much more difficult to sell than land with a house because there is less demand for land than for houses already built.
“Most people can’t buy land and build something on it,” says Fleming. “It takes a lot more time and money than people expect. Even though it is a upper fixer, people want something that they can start and work from there.
While there are fewer institutions that provide home loans than other types of home finance, it’s still a good idea to shop around if you can to make sure you’re getting the best deal possible.
How do land loans work?
Some mortgage lenders require a substantial down payment – ranging from 20% to 50% of the purchase price – and charge higher interest rates. Some home loans also have much shorter repayment terms than a 15- or 30-year mortgage, or other requirements, such as an area cap.
However, the process of applying for a land loan and receiving the funds is somewhat similar to that of a typical mortgage. The lender will assess your documentation of your financial situation and perform a credit check, and you will pay off the balance with interest over a predetermined period of time. Some land loans are structured as balloon mortgages, with interest only or no payment for a fixed term, then the balance due in one large payment.
“You may need to have a plan to pay it off before payment is due,” says Fleming.
5 types of land loans
1. Land loans lenders
Community banks and credit unions are more likely to offer land loans than large national banks. Your best bet is to find a lender with a presence near the land you want to buy. Local financial institutions generally know the area and can better assess the value of the land and its potential.
If you don’t plan on developing the land, interest charges will be high, Fleming says, and a lender could require a down payment of up to 50%.
As you would with any loan, shop around before you apply.
2. USDA loans for rural housing sites
If you are planning to build a primary residence in a rural area, the United States Department of Agriculture (USDA) has two loan options to consider:
- Section 523 loans are designed for borrowers who are planning to build their own home.
- Section 524 loans allow you to hire a contractor to build a house for you.
Both loans are designed for low to moderate income families and have a repayment term of only two years. Interest rates, however, can be low. Section 523 loans, for example, charge only 3%, while Section 524 loans charge less than the current market rate, with your specific loan rate set at closing.
3. SBA 504 loans
If you are a business owner and plan to use the land for your business, you may be eligible for a 504 ready through the United States Small Business Administration (SBA). With a 504 loan, you, the SBA, and a lender contribute to the cost of purchasing the land:
- The SBA grants a loan of 40 percent of the purchase cost.
- A lender grants a loan corresponding to 50% of the purchase cost.
- You contribute 10% in the form of a deposit.
The interest rate on a 504 loan will be based on current market rates. However, other loan terms may vary depending on the lender.
4. Home equity loan
If you already own a home with significant equity, it might be worth getting a mortgage. home equity loan instead of a land loan. No down payment is required on a home equity loan, and you can usually get a low interest rate no matter what you plan to do with the land because your home secures the loan. Depending on the lender and the loan, the repayment term can be between five years and 30 years.
The big downside is that if you don’t pay off the loan, you could lose your home. Also, since you are not using the loan to buy, build, or significantly improve the home used as collateral, the mortgage interest you pay is not tax deductible.
5. Vendor financing
In some cases, the person or company selling the land may be willing to offer owner or short term financing.
However, the typical seller is not in the lending industry and does not have a large loan portfolio like a community bank or credit union, so you can expect high interest rates and a down payment. important. Moreover, you are unlikely to get a long repayment term. Only consider this option if you cannot qualify for any other type of mortgage.
How much loan can I get for a piece of land?
There are no general rules about how much you can borrow with a land loan, and loan amounts can vary depending on the type of land you are purchasing and the mortgage lender you are working with.
A lender can help you finance up to 85% of the cost of developed land, for example, or 70% of the cost of raw land. Keep in mind that the amount you can borrow is directly related to the amount of money you have available and can put on the transaction.
Land loan rate
Since mortgage loans carry more risk, lenders tend to charge higher interest rates – up to 5% or 6%, and that’s just the start. Depending on the property, your down payment, and your creditworthiness, you could end up paying a higher rate than that. Since these loans tend to be more expensive, it is all the more important to take the time to compare several lenders before choosing just one.
How to get a land loan
Before you start looking for a loan, Fleming recommends making a comprehensive plan of what you want to do with the land. This can help you determine the type of loan and the terms that best suit your goals.
If you haven’t found a site yet, use sites like LandWatch, LandSearch and Land.com to search for properties based on your preferences and what you plan to do with the land. You can also use these sites to get in touch with a real estate agent who specializes in buying land.
As with any other type of loan, it is important to shop around. It may be a good idea to work with a broker experienced in home loans, but if you want to shop around on your own, a place to start is to see if you qualify for any of the government sponsored loan programs. You may also want to get in touch with local lenders and credit unions, who may be more likely to provide you with this type of financing.
Do a quick online search to find mortgage loan providers in your area. Make sure you read the requirements carefully and contact a loan officer to discuss your situation and your chances of being approved.
Advantages and disadvantages of the land loan
Home loans are used in quite specific circumstances, so they are not useful for a large part of home buyers. Here are a few ways they might make sense to you and others that won’t:
- Easy way to finance a project if you buy empty land and build a new house for yourself
- Government programs can help you get low interest rates with little or no down payment
- Can help small business owners relocate to a new location
- Can be difficult to find a lender
- May be charged a high interest rate or need to leverage your home equity if you don’t qualify for a government program, which could put your current property at risk
- Could have a short repayment period which means high monthly payments until the debt is paid off
According to Fleming, taking out a land loan to buy and build from scratch isn’t for everyone, “but those who do are usually quite happy when their project is finished.”
If you already have a secured land loan and didn’t get it through the SBA or USDA programs, your next step is to connect with a construction loan lender. Check out Bankrate’s guides for house building loans and some of the top construction loan lenders for more.