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Land Loans: Everything a Buyer Needs to Know

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Traditional mortgages are easy to find, but land loans might be harder to come by. These loans are used to buy property without a home on it — whether you’re planning to build your dream house or a new location for your business, you might need a land loan to make it happen.

We’ll go over the basics of land loans, how they work and where to get them.

What is a land loan?

A land loan is a way to finance property that doesn’t have a house built on it. There are several categories of land, and the type you’re considering will likely have an impact on the type of loan you can get:

  • Raw land. This is land with no improvements (such as water and sewer lines or road access) that would help make the property buildable.
  • Unimproved land. While similar to raw land, unimproved land may have some basic infrastructure or older structures, but generally doesn’t have all of the water, electric and other utilities you’ll need. This land may have once had a house on it, but doesn’t any longer. This may also be referred to as “undeveloped” land, but must typically be conducive to building a home in the future.
  • Improved land. This type of land has access to utilities and roads and is ready for building a house. These parcels may also be known as lots.

How do land loans work?

Like a traditional mortgage, land loans require a down payment, are secured by the property they purchase and paid back over time. You’ll work with a loan officer, who’ll help you apply for the loan and check your credit. Land loans can come from banks or credit unions, specialty lenders or government programs. However, not every mortgage lender offers land loans.

“The borrower would follow a similar process to that of a traditional home loan, but would not have the same number of lenders available to shop,” said Sue Smith, division manager at Amerifirst Home Mortgage’s Loan Center. “Typically the requirements are more stringent — more money down, better credit scores required.”

That’s because regardless of where they come from, land loans typically represent a bigger risk to the lender. You’ll face higher down payment requirements and will likely need a better credit score to qualify.

The Federal Deposit Insurance Corp. sets minimum down payment requirements for land loans, though individual lenders may decide to set more stringent standards. The FDIC standards are:

  • Raw land: Minimum down payment of 35%
  • Unimproved land: Minimum down payment of 25%
  • Improved land: Minimum down payment of 15%

9 types of land loans

Since land loans are different from traditional mortgages, they can be harder to access — but you’re not without options. Here are a few ways you might be able to finance land.

  1. Bank or credit union loan
  2. Government land loan programs
  3. Home equity loan
  4. HELOC
  5. USDA loan
  6. SBA loan
  7. Seller financing
  8. Personal loan
  9. Buying a teardown

1. Bank or credit union loan

While not every lender offers land loans, you’ll be able to find many banks and credit unions that do offer loans to buy land. There are also specialty lenders like farm credit organizations that offer land loans.

Banks and credit unions may have different programs for raw land and improved land. Typically, the more developed the property, the lower the down payment you’ll need. You may also find different loan programs depending on how soon you plan to build a home on the property.

If you’re starting the build imminently, you may choose a bank or credit union’s construction loan. These loans operate like a line of credit during the building period, with the money disbursed as construction progresses. At the end of construction, these loans typically convert to a traditional mortgage.

2. Government land loan programs

Both the FHA and VA have land loan programs to help finance the purchase of land and, subsequently, a new home.

The FHA construction loan program is open to people with a credit score as low as 500 with a 10% down payment. You’ll close once, and the FHA construction loan will convert to a traditional FHA mortgage when the project is complete.

VA loans are for eligible military service members and veterans. The VA land loan program is only open to people who will then use a VA loan to finance their new home. The land will need to be improved, meaning it has road access and safe water utilities.

3. Home equity loan

If you own a home with a significant amount of equity, you may be able to take out a home equity loan and use the proceeds to buy land. Equity is the difference between what your home is worth and how much you owe on your mortgage.

With a home equity loan, you’ll receive a lump sum upfront and pay it back over time, usually at fixed rates. You’re not limited in what you can use the money for, and if you have enough equity, you may qualify for a large enough home equity loan to buy the land parcel you’re seeking. But be aware: Home equity loans are secured by your property, meaning you risk losing your home to foreclosure if you’re not able to make your payments.

If the equity in your home isn’t enough to buy land outright, you may be able to use your home equity loan to make a down payment on a land loan from a bank or credit union.

4. HELOC

Home equity lines of credit (HELOCs) are another type of loan that leverages the equity you have in your home. Instead of getting a lump sum, you have an account that you can draw from over time — up to a set limit. At the end of your draw period, you’ll start paying back the amount you borrowed, with interest; not that these loans often have variable interest rates. You may be able to use a HELOC to make a down payment on a land loan.

5. USDA loan

The USDA loan program offers financing for buying land if the borrower is planning to build a home. Only low- to moderate-income families are eligible, and the land must be in a qualified rural area. Unlike traditional USDA mortgages, these loans are only available with two-year terms. The USDA also offers single-close construction loans that will finance the land purchase and construction, then convert to a long-term mortgage.

6. SBA loan

If you’re looking to buy land for a business property, you may be able to use a small business loan. The U.S. Small Business Administration (SBA) loan program allows borrowers to finance raw land and the construction costs of building a commercial building. A private lender will need to finance half of the project, and the SBA contributes another 40%. The business owner puts in the remaining 10%. Loan terms of 10, 20 or 25 years are available. The SBA says projects of at least $250,000 are a good fit for this program.

7. Seller financing

Seller financing, also known as owner financing, is when you get a loan from the seller of the property, perhaps instead of a traditional lender. You can also use seller financing for part of the purchase price. This can be a good option when a traditional loan isn’t available.

8. Personal loan

A personal loan is typically unsecured and can be used for a variety of purposes, including buying land. You’ll usually need good credit to qualify, but you’ll still likely pay higher interest rates than for other types of loans. These loans also tend to have shorter repayment periods.

9. Buying a teardown

With a teardown, you’re buying and demolishing an existing house, then replacing it with a new one. Lenders will typically be more cautious about financing this type of project, but you may be able to use a construction loan for this option.

Pros and cons of land loans

Pros

  You can build your dream home. Instead of buying an existing home, buying land then offers you the chance to start from scratch and build a new home that’s exactly the way you want it.

  Build on your own time. If you choose a raw land loan, you can hold on to the property for a number of years until you’re ready to start construction. Note that construction loans may not give you this opportunity.

  Single-close options make construction easier. If you’re ready to build, construction loans have the advantage of financing your land purchase and the cost of new construction, converting into a traditional mortgage when you’re ready to move in. You’ll only close once, making the process easier.

Cons

  Raw land may be harder to sell. Buying land can be riskier than buying a house, especially if the economy isn’t booming. “Land does not appreciate in value in the same way as improved property,” Smith said. “When economies get ‘soft,’ land is more difficult to sell than improved property.”

  Land may not be buildable. You’ll need to ensure that the property will be able to support a home in the future if you are planning to build, especially if you’re buying unimproved land. This isn’t always the case.

  You’ll face tougher qualifying criteria. Getting a land loan is often harder than a traditional mortgage. You’ll likely need to present a better credit score and pay a higher down payment to qualify.

  Loans can be harder to find. Not all lenders offer land loans — you may need to shop around for longer to find a good option.

You made your land purchase — now what?

Once you’ve bought the land, you can now start to plan for what you’d like to build on it. There are several different options you can choose to finance construction, whether it’s a residential home or a commercial building.

Here are a few of the more common ways to pay for a construction project on your new piece of land:

Construction-to-permanent loan. Many banks and credit unions offer these types of loans, specifically designed for building a home. Money is paid out as construction progresses, and the loan converts to a traditional mortgage when you move in.

Construction-only loan. Much like a construction-to-permanent loan, these loans pay for construction of the home as it happens. However, it will not convert to a traditional mortgage. You’ll need to pay the balance in full at the end of construction, or refinance to a new loan that pays off the construction loan. This type is also known as a two-time close construction loan.

FHA construction loan. These loans are backed by the Federal Housing Administration and offer a one-time close construction-to-permanent loan. You can qualify with a credit score as low as 500.

VA construction loan. The Veterans Administration allows qualified military service members or veterans to finance a home construction using a VA loan. This is also a one-time close loan.

Owner/builder loan. If you happen to be a general contractor, you may be interested in supervising the construction of your home yourself. Some lenders offer owner/builder loans, where the owner of the home is also directing construction.

SBA loan. If you’re building a new location for your business, you may qualify for a SBA 504 loan. These small business loans may be used to construct new buildings and are paid back with 10-, 20- or 25-year terms.

Hard money loan. If you don’t have many traditional financing options, you could turn to a hard money loan to finance your construction. These loans are secured by the property, but generally require a higher down payment and higher interest rate than other options.