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 land mortgage 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 when you are buying a home. So, it’s highly unlikely 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.
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. There aren’t as many lenders offering this type of loan as it is a higher risk for them. 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 a homeowner will do as much as they can to keep their home. Having nowhere to live is going to 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 rates of interest can also be expected over a standard home mortgage.
If your land loan is going just 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 lots of horror stories of buyers and the builders they choose to work with.
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. They include 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.
- Make sure that a title search is done and that it is feasible to get title insurance to protect your investment.
Types of Land Loans
There are a few different types of loans you may encounter 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.
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. In the early stages of the loan, you’ll only be paying the interest on the price of the land.
Once construction on the home begins, you” be given what’s known as “draws” from the bank in order to pay for phases of construction as the house is built. For example, you may receive a draw when you dig the hole for the foundation 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 is keeping tabs on the money going out is used 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 the construction of 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 the loan will be backed by HUD.
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. You should research 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 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 give you the opportunity 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.
4. Standard Lender Loans
When you are going to be 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 be able to help you, but local credit unions or community banks could be the answer. They will have a better understanding of the market in your area 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.
5. Home Equity Loans
If you already have a home, you could use the equity of your property to buy the land. This 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.
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 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, however.
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 than a higher interest rate than what you would expect to pay from a traditional land lender.
Understand The Land You’re Buying
While working as a real estate agent over the past thirty-three 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.
For example, does the land have a sewer hook-up, or does it need a septic system to be 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. There are several things that can have a significant impact on the costs, including how high the water table is and the kind of 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 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 highly unlikely you will be able to get a building permit.
All of these things need to be taken into consideration before getting a land loan to eventually build a home. 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.
The Right Land Loan For You
Whatever you want the land for, make sure you investigate all your options before committing to a loan. You need to have a 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 be able 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.
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 33+ years.
Are you thinking of selling your home? I have a passion for Real Estate and love to share my marketing expertise!
I service Real Estate Sales in the following Metrowest MA towns: Ashland, Bellingham, Douglas, Framingham, Franklin, Grafton, Holliston, Hopkinton, Hopedale, Medway, Mendon, Milford, Millbury, Millville, Natick, Northborough, Northbridge, Shrewsbury, Southborough, Sutton, Wayland, Westborough, Whitinsville, Worcester, Upton, and Uxbridge MA.