Everything You Need to Know About Land Loans | Mortgages and Advice

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Buying land can open potential for business, investment or building a home, but lenders typically don’t offer traditional mortgages for land without a valuable structure on it such as a home. Specialized land loans can be used to finance land purchases, but you should understand the limitations, benefits and drawbacks of land loans before you apply for one.

Read on to learn about getting a land loan if you want to buy land and need to finance it.

What Is a Land Loan?

Just as mortgages are for buying homes, land loans are for purchasing property without a home built on it. The property typically secures a land loan, so if you default, the lender may take ownership of the land to recoup its losses – just as it would if you defaulted on a mortgage.

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But land loans are riskier for lenders than mortgages. In a financial bind, most people prioritize paying their rent, mortgage or car payments so they don’t lose access to their home or method of transportation. Not so with land loans. Land doesn’t generate income in most cases, and if you don’t live on it, you have nothing to lose other than the land itself.

“It’s something that most folks can pretty easily walk away from if they’re in trouble,” says Casey Fleming, mortgage advisor at C2 Financial Corp. and author of “The Loan Guide” and “Buying and Financing Your New Home.”

At the same time, land can be more difficult for lenders to sell if the borrower defaults. Land just isn’t as in demand as homes.

For these reasons, the features of a land loan are traditionally less favorable than those of mortgages. Land loans may feature higher interest rates or require a down payment as high as 50%.

“The terms are specific to the bank or lender doing it because it’s not a standard loan option,” says Dave Krichmar, a mortgage banker in Houston. “It’s not like a 30-year mortgage with industry-standard interest rates.”

Types of Land Loans

There are three types of land loans:

  • Raw land loans: Undeveloped properties with no roads or utilities are considered raw land, generally with low prices compared to developed land. Raw land loan borrowers may face higher interest rates and larger down payments than improved land loans or traditional mortgages.
  • Unimproved land loan: Properties with basic road access and utilities are unimproved. These loans may offer better terms than raw land loans but not as good as improved land loans and single-family home mortgages.
  • Improved land loan: With full access to roads and utilities, improved land usually commands higher purchase prices than raw or unimproved land. While you’ll pay more for the property, improved land loans generally have smaller down payments and lower interest rates than comparatively riskier raw or unimproved land loans.

How to Get a Land Loan

If you’re applying for a land loan, consider various lenders. Large national and online lenders may not have the local knowledge necessary to assess whether a loan for a particular property is risky, so they may not be as open to financing land as local lenders are.

The best places to get land loans are often local or regional banks and credit unions because they know the area’s market.

“The key is finding a local bank in the area where you’re looking to buy land,” says Krichmar. “Lenders in the area are usually the best option. A lot of the major banks don’t offer land loans anymore.”

Applying for a Land Loan

To get a land loan, you must complete an application and provide information about employment, income, debt and assets. Fleming says, “They want to know as best as possible that you aren’t going to walk away.” Lenders look for applicants with a strong credit history and a lower debt-to-income ratio than you usually need for a mortgage.

You also may be required to provide more detailed information in a land loan application than you would for a mortgage. When you’re taking out a mortgage, the home is already constructed and the land’s use has already been determined, which makes the mortgage process easier. For land loans, lenders often need detailed information about the property you’re purchasing and your plans for the land. The potential future value of the land can vary depending on these factors.

Eligibility requirements vary depending on the lender, but lenders usually want land loan borrowers to have a credit score in at least the upper 600s and a debt-to-income ratio of 43% or lower. You might need to make a down payment of up to 50%.

Pros and Cons of Land Loans

Land loans can offer flexibility, but you shouldn’t expect the same availability and terms on a land loan as you would for a traditional mortgage. Consider these pros and cons of land loans:

Pros of Land Loans

  • You can use a land loan to buy a property even if you don’t want to build immediately.
  • Land loans allow you to build a home or develop your business with flexibility.
  • Land loans may be cheaper than alternatives such as personal loans.

Cons of Land Loans

  • Fewer lenders offer land loans than traditional mortgages.
  • Terms for land loans are generally less advantageous than traditional mortgages, requiring larger down payments and higher interest rates.
  • Even if construction stalls or fails, you’ll have to pay your land loan.

Other Lending Options for Land

  • Construction-to-permanent loans. These loans give you money upfront to buy the land if you plan to build a home immediately. These loans also allow draws to help pay for construction costs until the house is completed, usually within 12 months of closing. 
  • Home equity loans. If you own a home, you might use a home equity loan to finance the land. In general, you can only borrow on your equity – meaning the difference between your home’s value and what remains on your mortgage – if it’s more than 20%. So, if you have 35% equity in your home, you could borrow against 15% of your home’s value. These loans normally offer lower interest rates than land loans because homes are easier to sell should a borrower default.
  • Seller financing. The current landowner may offer financing to encourage buyers. In these cases, the seller sets the loan terms and what qualifications you must meet to purchase and finance the land. If you decide to move forward with seller financing, have a qualified real estate lawyer review the deal and the loan. Once the deal is closed, you’ll make payments directly to the seller unless that person sells the promissory note to an investor.
  • Unsecured personal loans. You may even be able to use an unsecured loan, such as a personal loan, to buy land. These loans typically have higher interest rates and shorter repayment periods than a traditional secured land loan. A personal loan might work for you if the land you want is inexpensive.

How to Find the Best Land Loan for You

Shopping for a land loan isn’t as easy as shopping for a mortgage. Online tools that allow you to compare loans quickly aren’t common for land loans like they are for mortgages. Instead, you have to investigate which lenders in your area finance land purchases and compare the terms each lender offers. Sometimes, a lender can match or beat a competing offer to secure your business.

When examining multiple land loan offers, you want to pay particular attention to the loan’s fees and interest rates. These can vary from lender to lender. Get several quotes and ask for line-item estimates so you can compare each loan offer effectively, Fleming says.

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