If you are considering purchasing land to build a home, it is important to understand that the loan necessary to purchase the land will be quite different compared to your regular mortgage. Here are some of the key points to understand when you are pursuing a land loan:
1 – Not All Land is Created Equal
As stated above, not all land is the same. Land can have a variety of improvements, many which are necessary to have when you are building a home. For the sake of looking at loans you will want to determine if the land where you want to build your home is improved land or raw land.
Improved land will be easier to obtain a loan for. The land, in most cases, is already developed for use. This means it has access to many necessary services, such as sewers, roads, and water. Raw land on the other hand is going to be more difficult to work with. This land is not ready for a home and requires more work, including planning and permitting, prior to construction. For this reason, some lenders do not consider raw land when working with land loans.
Another factor to consider with the land is that you will need to pay for a survey if one is not already provided, which will identify the boundaries of the land.
Lastly you will need to look at the zoning of the lot – you will need to confirm that the land is zoned for your intended use. If it is not zoned for your intended use, it may not be the right lot for you. There is the possibility of going through the appropriate processes with the city or county to get it rezoned thought this s no guarantee or rezoning. And, this can be costly and time consuming. You will also need to check if there are any land-use restrictions and review what developments are anticipated in the surrounding areas. A complete due diligence will be beneficial when presenting to the lender.
2 – Not All Banks Give Land Loans
Once you have identified the land, it is time to pursue a loan. However, not all banks and institutions will provide land loans. In fact, many larger banks do not work in this sector. The most probable way to obtaining a land loan is by contacting a local credit union or bank. We also have mortgage brokers that will lend on land.
There are other popular financing options. The first is to find a lot that offers seller-financing. There are no set guidelines for what the seller-financing would include, but instead this is an agreement between the land owner and buyer. This option can be advantageous to those who are unable to obtain a loan or those who are offered a loan with unfavorable terms. The second option to pursue is looking at a home equity loan. This is only possible if you already own a home because you are borrowing the equity of the existing property.
3 – The Terms and Rates Will Be Less Favorable
In most cases a land loan will require a higher down payment (up to 50%) and will have a higher interest rate. This is because land loans are much riskier than a traditional mortgage. When a bank provides a loan for a home, they have the ability to take back the home if the borrower does not make their payments. In the case of a land loan, the lender only has the land to take back, and banks and institutions do not find this scenario favorable. If a bank forecloses on a home, they can usually sell it fairly quickly to recapture their losses. However, land is more difficult to sell, so the lender doesn’t always get their money back.
The terms of the loan also still depend not only on the property itself, but on the qualifications of the borrower. A higher credit score, proof of consistent income, and a good debt-to-income ratio will be beneficial to any borrower.
The Major Differences Compared to A Mortgage
In the end, any lender will be much more interested in working with you for a traditional mortgage. Here is a summary of the major differences:
- There will be more options for a mortgage compared to a land loan.
- The interest rate will be higher for a land loan.
- You will need a larger down payment for the land loan.
- The term will usually only be one to five years, versus the 15 or 30 year terms for a home. Some institutions offer longer term land loans.
- The loan may be contingent on the survey or changes in zoning.
- The land loan may be denied because of future development in the area that may impact the construction of a home.
This summary will help guide you towards obtaining a land loan. However, if you are considering building a home, you may want to look at a construction-to-permanent loan. This may provide you an option for building your dream home while facing the challenges of finding a lender for a vacant plot of land.
Steps to Getting a Land Loan
If you are still interested in purchasing land, follow these simple steps to get started.
- Learn about the available land where you want to purchase and identify if the land is classified as improved. Consider consulting with a real estate agent during this phase.
- Talk to multiple lenders to get a comparison on terms. First identify if they will provide the loan, see if you are qualified, and get a quote.
- Determine if the land loan is your best option.
- Build you dream home!