What Are Land Loans?
Are you considering getting land loan financing? The idea of building a home can seem great until you realize the costs involved. A land loan can be the answer to buying the lot to build your dream home.
Land loans, however, are a bit different than traditional home financing. It is worth understanding all of the nuances involved. Maximum Real Estate Exposure has an exceptional resource on a land loan worth reading.
If you want to build a new home, a loan for land will allow you to buy the building lot and then start constructing a home down the road. They can also be used when you want to buy land for business reasons as well.
There are a few different types of loans for land available, depending on what you will use the land for and where the plot is located.
Let's look closer at the three most common types of land loans you are likely to encounter.
Raw Land Loans
If you are looking to buy a plot of land that hasn't been developed, a raw land loan could be right for you. If the land isn't connected to a road, electricity, or sewers, this will be the sort of loan you need.
Generally, lenders are less interested in financing the purchase of such a building plot. This is because it creates more risk for them, with a greater chance that the home doesn't get completed. Due to this problem, you can expect to pay higher interest rates, find a larger down payment, and need a good credit history.
Purchasing an undeveloped plot will be cheaper than land that already has utilities ready to be connected. You will have to spend more on interest payments, meaning that you won't make quite the saving you initially think you might.
If you are applying for this type of loan, you need to make sure you have a solid plan to show the lender. With the land's development carefully planned out, the lender can see that you are committed to the project and are likely to be less of a risk for them.
Unimproved Land Loans
An unimproved loan is similar to a raw loan, the difference being that there are some utilities ready to be connected to the new home. Perhaps the building lot has a road connected but lacks electricity, a septic system, or a public sewer connection.
This type of loan is less of a risk for the lender, and you can expect lower interest rates. They also won't demand such a high down payment, and you won't need quite as good a credit history.
Improved Land Loans
If you are looking to buy a plot of land that has access to all the utilities, an improved land loan will be available to you. If there is a road, water, sewage, and electricity really to connect, you could get an improved loan.
This will have even lower interest rates than the unimproved loan, and you won't need to find so much money for the down payment. While you don't have to find a high down payment, it could be better to get one anyway if you want to reduce your loan cost.
How Loans for Land Differ
Though getting a loan for land is very similar to a traditional home mortgage, it is riskier for lenders. Since there isn't a home already constructed, it won't be as easy for the lender to get their money back should things go wrong. It can also be more difficult to value the land since the house has yet to be constructed.
Having a good credit score helps when getting any type of loan, and it is vital here as well. You also need to set out what you intend to do with the land and explain as much as you can to the lender. If there are zoning or land use restrictions, you need to explain this to the lender.
The lender will want to see how much access the plot has to utilities, so this has to be outlined in your loan application. Typically, you will need to hire a land surveyor and have a property survey completed. Lenders want to have a land survey done to make sure it complies with local zoning laws, and there are no encroachments from the neighbors.
Having a property survey done helps with their risk assessment. This information will be used to set down payment requirements and the interest rate you will have to pay for your loan.
Applying for a Land Loan
When you are looking for a lender for your land loan, you might find a better deal from a credit union or community bank in your area. If you are buying a plot of land in a rural area, and it will be your main residence, the USDA might be able to help.
The USDA loans program is designed with lower-income families in mind, has low-interest rates, and might not need a down payment.
If you are buying the land for a business, the Small Business Administration operates its 504 loan program. This helps business owners fund the purchase of land with repayment, typically over 10 to 20 years.
Alternative Land Loan Options
If you don’t like the terms of a land loan, there are some other options to fund the purchase.
Home Equity Loans
If you have equity in your current home, you could use it to help buy the plot of land. It will mean that you don’t need to find a down payment, and the interest rates can be fairly low. The downside is that your home is at risk if you don’t keep up repayments.
This option, often known as seller financing, allows you to avoid traditional lenders and the restrictions you might be placed under. Instead, the buyer will agree to a mortgage from the seller of the land. If the seller is willing to enter into this arrangement, it can be a more flexible option than a traditional mortgage.
If you are planning on building your home right away and the land is ready to be constructed on, you might want to opt for a construction loan. A construction loan will allow you to purchase the land and finance the building of the house all in one mortgage. This is the most popular loan choice for those who are going to build their own house.
Make Sure You Understand Costs Before Buying Land
One of the areas you will really need to spend some time researching before buying a piece of land is the development costs. Some lots are easy to develop, while others can be more challenging and far more costly.
For example, is there any ledge on the property that will need to be blasted? Is there a high water table that will make a septic system expensive? Are there any wetland restrictions that could impact your costs?
These are the kind of questions you need answers to before writing a check to buy a piece of land. Land expenses can really add up. No two pieces of property are alike. It makes performing due diligence critical in any land purchase.
Closing Thoughts on Getting a Loan For Land
If you really want to build your own home, there is a lot to think about. There are many pros and cons to new construction. Getting a loan for the land can be overlooked and might be more costly than you expect.
You should carefully consider choosing a land loan and whether it is right for you in your situation. Hopefully, you have found this information on purchasing land to be useful.