What to Know About Mortgages For Land
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 that will be available from fewer lenders.
When you are purchasing land, there is often a more significant down payment requirement than buying a home. So, it’s doubtful you will be able to put down a minimal amount of money with a land purchase.
Quite often, with land mortgages, there will be a higher interest rate and less time to repay the loan than you will experience with a house. These are obviously essential considerations to know when moving forward. If you decide to apply for a land loan, it’s vital to know the ins and outs.
Loans for land are far less commonplace than mortgage financing for a home. Given this, it can be more difficult to get a land loan. There are far fewer lenders that provide land loan financing when compared to homes.
Let’s review the options if you need help to purchase land.
What is a Land Loan?
Land loans allow for the purchase of land to build a home or for other reasons. As mentioned, there aren’t as many lenders offering this type of loan as it is a higher risk.
Empty land usually is harder to sell than land with a property on it. This means that if the borrower fails to follow the payment schedule, the lender will have a harder time recovering the money.
There is also an increased possibility of a borrower walking away from the land if they run into financial difficulties. This is more likely than with a typical mortgage, as homeowners will do as much as possible to keep their homes. Having nowhere to live will be more of a motivation than the loss of a vacant plot.
The process of building a new home from scratch is also a more daunting prospect than many people realize. This can lead to more people giving up on their dream of building their own home and ending up in foreclosure on the land.
These risks mean that 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 is going to be for a short amount of time, and you plan on hiring a builder, don’t forget how critical it is to vet the builder. When purchasing new construction, there are a ton of 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.
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 considered virgin soil with no roads, sewer systems, or public utilities. When this is the type of land you’re interested in buying, you’ll need to get a raw land loan. Getting a loan for land in this state is far more difficult. It is typically reserved for developers who have experience with building subdivisions or some business purpose.
When choosing a raw land loan, it will be vital to put together a comprehensive plan to show the lender exactly what you intend on doing. Land loan lenders will want to feel confident they will be lending on a project that will be successful.
In order to get this kind of mortgage loan, you will need to have a substantial down payment and good credit history. Lenders want to minimize their risk in lending, and this is how they go about doing 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.
Unimproved Loan For Land
An unimproved land loan is like a raw land loan, but the land is slightly more developed. With this type of loan, you will typically see some utilities installed at the property, usually at the street. These loans for land 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 there are some utilities 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
Improved land loans are much more ideal for lenders, given the lower lending risk. An improved land loan is for vacant land that has improvements nearby, such as roads, water, electricity, and other utilities. Land that is ready to be developed by either a builder or homeowner is much more expensive. The purchase price will be significantly higher than undeveloped land.
Given the fact, there is less risk with an improved land loan; you can expect interest rates to be a little bit better and possibly slightly more relaxed down payment requirements. This type of 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 will at some point end up with a traditional mortgage for their primary residence, which they typically intend on custom building. Folks who get a land loan are often not interested in building a cookie-cutter home you can get anywhere but their dream home with significant custom features. This type of land loan is the most common.
A vacant lot ready to build in many parts of the country is difficult to find and often can be very expensive.
Key Considerations With Land Loans
There are quite a few things you’ll want to investigate 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 in order to get land financing.
- 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.
- Understanding whether the lot is serviced publicly or privately (city sewer vs. septic system).
- Is the land serviced by municipal water, or do you need a private well installed?
- Ensure there is access to utilities and public roads.
- Make sure to investigate whether any easements encumber the land, especially ones 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 of these items 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 look to 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 with a local real estate agent that works with new builds. As previously mentioned, land loans 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 the purchase of land when you also know exactly what you’re going to build is a construction to permanent end loan. This type of 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 along with other details of the project. Your building plans will need to be a detailed set of blueprints, not an 8×11 sketch.
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” be given what’s known as “draws” from the bank to pay for phases of construction 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.
By providing draws, the lender keeps tabs on the money going out for its specific purpose during construction. These phases are often inspected by a member from the bank or a hired third party. The lender wants to make sure the money they are lending is going towards constructing the property and not something else.
When the construction is done, it will convert to a permanent 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 Tweet
2. FHA Construction to Permanent Loan
FHA also has a construction to permanent loan option. With this land purchasing option, you must be starting your home construction project right away. 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 you have at least ten percent down. Before meeting with a lender, it would help if you researched this upfront.
It is almost certain that borrowers with a credit score between 500 and 570 will need to 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, it is always advisable to get a copy of your credit report and check for errors. A mistake could impact your ability to get the best loan terms.
Remember that lenders have their own requirements for eligibility, so their standards can be higher than HUD.
3. USDA Land Loans
If you want to build your home in a rural area, the U.S. Department of Agriculture could offer an option. The USDA has Section 523 loans to buy the land and Section 524 loans to pay for the build. This could be an option if you meet their lower-income criteria, and they provide low interest rates as well. The downside is that the loans need to be repaid in only two years.
Section 523 loans work for borrowers who want to build their own house, while Section 524 loans allow you to hire a contractor to build a home for you.
Both loans are designed for low to moderate-income families. Do keep in mind the qualifications of 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 USDA land loan 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
When you are buying land and not starting construction on a home for a more extended period, a land-only loan is the best option.
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 right away, 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 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 to pay and no down payment. The downside with this is that your home is at risk if you fail to keep up with the payment plan.
Additionally, because the loan isn’t being used to buy, build, or substantially improve your home, the interest you pay is not tax-deductible. The usual repayment of these loans is between five and thirty years.
A home equity line of credit may be good for some 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. Their 504 loan program will be partly financed by this government agency and a lender of your choice. You will need to find 10 percent of the purchase cost, with the SBA covering 40 percent and the lender the 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. Quite often, these kinds of loans are used when someone is doing a commercial building project.
7. Seller Land Loan Financing
It can sometimes be possible to get finance for the land from the business or person you are buying it from. 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.
Keep in mind if a seller is willing to finance the land purchase, they are probably interested in making it worth their while. 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 is probably going to be one of your more expensive options.
Use a Credit Union to Get a Loan For Land
One of the best places to try for a land loan is your local credit union. Credit unions are usually not averse to doing financing for land purchases. Quite often, a credit union will offer lower interest rates than other kinds of lending institutions. Credit unions are well known for giving lot loans for individuals to build their dream homes eventually.
Another good avenue to try is a local bank or community bank. These lenders will often go out of their way to a mortgage loan, whether it is for business purposes or individual use. Local and community banks are some of the primary land loan lenders you should try first. You will often get more favorable terms than other land loan lenders.
If the land is not terribly expensive, you might also be able to 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 as well as Puerto Rico. You can get more information on their website.
FAQ’s With Land Loans
These are some of the most frequently asked questions when getting a land loan, along with their answers:
1. How Much Do You Have to Put Down With a Land Loan?
You will need to have at least a twenty to thirty percent down when purchasing a buildable lot. When you buy raw land, the down payment requirement can be as much as 30 to 50 percent down.
2. Which Loan is Best For a Land Purchase?
The best loan for land purchase is one of the specific land loan options discussed, seller financing, or possibly an equity loan if you already own a home.
3. Can I Get a Land Loan With Bad Credit?
Like buying a home with bad credit, it can be far more challenging. You will need to be at least twenty-one years of age and show that you are gainfully employed with a steady income. The amount you can borrow will depend on the value of the land. Given it is a bad credit land loan, you will need to have a down payment of 40 to 60 percent.
4. Who Does The Most Financing For Land?
Surprisingly, most land loans are written by local lenders vs. large lending institutions. Credit unions and community banks are good sources of finding a land loan.
5. Will a Lender Take Land as Collateral?
It is hard to find lenders that will take the land as collateral but not impossible. Lenders that will take the land as collateral will want it to be worth a designated amount of money. It goes without saying you’ll also need to be the landowner with the title in hand.
6. Can Land Be Used as a Down Payment?
Yes, if you will be getting a construction loan to buy land and build a home simultaneously.
7. Is Land a Good Investment?
Absolutely – they aren’t making any more land, are they? If you are purchasing 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, land values go down.
Understand The Land You’re Buying
While working as a real estate agent over the past thirty-four-plus years, I’ve come to realize that most people are uneducated when it comes to buying land. There is a significant amount of research and considerations that 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 does it 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 how high the water table is and existing soil.
Septic systems are built according to these things. If you have a high water table, additional fill and soils will need to be brought in. If the existing soils are rocky, clay, etc., they will need to be removed and replaced with gravel.
What about any ledge on the property? Yes, that can be a huge 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 there are wetlands involved, you’ll need to follow strict guidelines on what can be done within a specified distance of the wetland.
Additionally, you may be required to do other things, such as putting up a silt fence. Local municipalities will issue what’s called 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 be aware the term “wetlands” does not necessarily mean a body of water. Wetlands are classified based on vegetation.
Investigation of whether there are any conservation issues should always be a prime consideration when purchasing land. Lastly, is the land serviced by public water, or will a private well need to be installed? Having a municipal water source makes things really 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 will also need to pass testing for both quality and quantity standards. The local board of health will regulate these tests. Without passing, it is doubtful you will be able to get a building permit.
These things need to be considered before getting a land loan to build a home eventually. Having a sewer connection will take some of these worries away.
It is NEVER advisable to buy a lot that does not have a sewer connection or an approved septic design. Without these things, you could be purchasing a worthless plot of land. Certainly, one that can’t be built on. Never get a land loan without knowing with one-hundred percent certainty the land is buildable.
The Right Land Loan For You
Whatever you want the land for, make sure you investigate all your options before committing to a loan. It would be best to plan for the land usage before you look for a loan. This will allow you to apply for the right loan and show lenders that you are less of a risk.
You also need to understand what loan terms are best for you. For example, are you going to pay off the loan quickly, or is a longer period required?
Buying land to build the home of your dreams is a big project, but if you have the right financing in place, it 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 have a better understanding of what you should know about buying land and getting a loan. There are many financing options, so it’s worth your time researching which is best for you.
About the author: The above Real Estate information on getting a land loan was provided by Bill Gassett, a Nationally recognized leader in his field. Bill can be reached via email at [email protected] or by phone at 508-625-0191. Bill has helped people move in and out of many Metrowest towns for the last 34+ years.
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