Are you wondering how land loans work? Maybe you’re setting your mind on purchasing a piece of land that wonderfully fits your future house? Getting a loan for land is a smart move, especially when you will not be constructing your home right away.
Procuring land financing is a great way to make your purchase on time. You can take out a mortgage for land the same way you would for a house—the only difference and inconvenience is the land’s assessment. Land value is more difficult to determine when compared to a home.
Let’s take a look at everything you need to know about acquiring a land loan, so your financing is an easy, carefree process.
Where Do You Get Your Loan?
Banks or specific lenders will grant you land loans. You can seek land lenders by asking around, possibly to a real estate agent or doing your own online search. Local credit unions are a great place to start. Quite often, local lenders are a great source for finding land loans.
Once you have found your lender of choice, they will analyze your credit history, along with the land’s market value. Then they’ll make a final decision regarding your eligibility to buy that land.
How Do You Obtain Land Loans?
The process of getting your land loan takes several forms; this is because there are several loan types. However, in all land purchase transactions, it would be best to have a great credit score, a good debt-to-income ratio and a continuous income.
Land is considered a riskier investment than a building. This produces a couple of consequences. First, you will have to pay more out of pocket for the down payment and the interest rate.
Secondly, land loans are usually granted only in the short term. The land mortgage expands over only two to five years. If you purchase this land to build a house, you might get a longer loan.
Land Loan Types
As we mentioned before, the process for obtaining your land loan varies according to the type of loan that you request. Here are the most frequent types:
Raw Land Loan
This applies if you intend to buy raw land; meaning there are no improvements or construction on it. There are no facilities either: no electricity, sewerage, road system, etc.
In this case, the risks are the highest for any lender. The risk increases proportionally to the time required to develop the land. Thus, this type of land loan is the most difficult to obtain.
You can expect high interest rates and larger down payment requirements. For the raw land loan, you will have to cover up to 50% of the amount. If you want to increase your chances of getting such a mortgage and get good terms, you need to present the lender with an elaborate and efficient land development plan.
This is the appropriate loan if you want to purchase a piece of land with a certain level of infrastructures, such as gas, water and electricity. The land most likely will be used for construction development, which is a safer investment for lenders.
They will be more inclined to grant you the land loan under such conditions. The more improved any piece of land is, the better chances of obtaining a land mortgage. Usually, the contract terms will be more relaxed as well.
The interest rates are lower than raw land loans due to less risk. You can expect the down payment requirements to be anywhere from 30-50% down.
Construction Land Loan
If you are building a home right away, you would be much better served with a construction loan. Construction loans provide funds to build the home that then roll that over into a permanent mortgage.
This type is a two-in-one loan. You can apply for a loan that covers both the land you want to purchase and the construction you want to develop on this land. However, this requires an excellent credit score (over 700), a low debt-to-income ratio and a high income—plus the construction development plans need to bring real value.
In this case, you will still have a down payment of 10-20%. The construction plans need to be developed through a professional and reputable developer.
You also have to present the precise construction timeline and the cost estimate. The lender might even recommend several trustworthy builders. If you work with them, your chances of getting a construction loan increase considerably.
Keep in mind that the lender will inspect periodically and get involved in all stages of construction. They will receive their money in several draws along the process. The draw schedule is agreed upon between you, the lender and the builder.
This type of land mortgage is a short-term one—the average being one year. During the construction period, you will pay interest payments; then the loan turns into a house mortgage, with a 15- to 30-year term. The home can be either modular construction or a traditional stick-built home.
Generally, all types of land loans are considered risky ones by any lender. Thus you can expect from the very start to have high-level interest rates. A good credit history gives you hope for better interest rates.
To give you a general idea, here are the average rates for a 10-year loan and a 30-year loan, respectively:
– For raw loans: 4.25-5.25% / 4.90-5.90%
– For lot loans: 4-5% / 4.65-5.65%
– For construction loans: variable rate (around 5.25%)
Choosing the Land
You have better chances at getting a land loan if you keep several land considerations in mind:
– Boundaries: They must be very well defined. It helps in establishing the land value. Usually, lenders will require a land boundary survey before deciding if you are eligible or not.
– Restrictions: Lenders want to know if the land is part of various ownership associations or covenants. It comes with liabilities that they might not be willing to undertake.
– Utilities: The more, the better for your land to make a good impression on your lender. They appreciate access to paved roads, electricity, gas connection, sewerage. If some of them are missing, present your lender with a thorough plan for adding them.
– Intended development: The value of the targeted land increases if the entire area is under development, such as if there are plans for shopping centers, residential buildings, highways, etc. Present your lender all of these, and you will quickly get your land loan.
Land loans offer a great financing opportunity for those who would like to purchase a piece of land to eventually either build their dream home or build some business opportunity. You should now have a much better understanding of how land loans work.
Bill Gassett is a nationally recognized real estate leader who has been helping people buy and sell MetroWest Massachusetts real estate for the past 33 years. He has been one of the top RE/MAX REALTORS® in New England for the past decade. In 2018, he was the No. 1 RE/MAX real estate agent in Massachusetts.