How Do You Get a Land Loan?

While prospective homebuyers often seek homes that are already built, there are some who have specific ideas about how they want their dream home to look. Those buyers are likely to consider having their home built from the ground up. While having a home built allows the future homeowner to have control over location, appearance, and all the bells and whistles, the actual process of getting land and construction loans to complete the dream can be complex and costly.

What is a Land Loan?

Land loans, also called “lot loans,” are used to buy a tract of land, upon which a house is commonly built. Similar to a mortgage, prospective buyers can get a loan through a bank or other lending institution with a similar qualification process. The land value is also taken into consideration. These types of loans often require a higher down payment and interest rate, as well.

How Do You Get a Land Loan?

Acquiring a land loan is very similar to getting a standard mortgage loan. Although different loan types have different qualifications, you’ll need a very strong credit score (around 720), and your debt-to-income ratio shouldn’t be any greater than 30%.

In addition to the financial requirements of obtaining a land loan, you’ll also need to submit an explanation about your intended use of the land that takes into account the various aspects of building, including zoning checks, utility access, use restrictions, and surveys. This information will allow the lender to make a thorough decision regarding approval, rates, and other terms of the loan.

The interest rates for land loans tend to be higher than those of standard mortgages because they are considered a higher risk due – the land is its own collateral and some lenders feel that a vacant lot disincentivizes loan defaults. Furthermore, unlike the decades-long repayment terms of a mortgage loan, land loans tend to only have two- to five-year repayment periods, often with a balloon payment at the end.

Examples of Land Loan Products

Before applying for a land loan, it’s important to determine exactly which type of loan product is needed. Let’s look at the most common types of loans that financial institutions offer.

Raw Land Loan

Raw land is totally undeveloped. This means that there are no utilities (i.e., electricity), sewage systems, or roads. While raw land offers a lot of flexibility, getting a loan for raw land is exceedingly difficult. Prospective borrowers should draft a detailed plan for how they plan to develop the land for the lender. They should also be prepared to pay a hefty down payment (generally around 20%, but up 50%).

Lot Land Loan

The difference between raw land and lot land is that the latter has some development or infrastructure on it. Lot land is generally zoned for residential development and may have access to public roads, utilities, a sewage system, and survey reports.

Qualifying for a lot land loan (aka improved land loan) can be much simpler than getting a raw land loan. However, lot land loans can also get complicated. For example, if your plan is to build your own home, you may face the prospect of having to take out three loans: one for the lot, one for the construction, and a third mortgage that would consolidate the payments on the previous two.

While lot land loans usually boast lower interest rates than raw land loans, the same stringent qualification standards and significant down payment applies. The terms on these loans can run for up to 20 years.

Construction Loans

A construction loan is a short-term, high-interest loan that is used to build property. At many financial institutions, the borrower has one year to complete the construction and a certificate of occupancy must be issued within that time.

Like land loans, borrowers must be prepared to submit project details, plans, and timelines at the time of application. Upon approval, the loan works like a line of credit where the borrower can access certain amounts as the project progresses. While building takes place, the bank may send an appraiser or inspector to assess the construction to authorize access to more funds. When the project is completed, the borrower converts the loan into a typical mortgage loan and begins to pay the principal and interest.

Things to Consider When Choosing Land & Lots

In the process of conceptualizing your dream home, you’ll want to think about what the bank will consider when you go in to apply for your loan. Here are key factors to focus on while choosing where to have your home built.

Surveying & Boundaries

Surveys are important in property ownership, and even more so when pursuing a land loan. Although it is not uncommon for homeowners to put off surveys, these studies are essential at the outset of pursuing a land loan. The lending institution will want to evaluate the merits of your loan request based on your specific parcel of land. Furthermore, it’s important to make sure that your land is surveyed by an accredited professional. Most lenders will require that your survey is an American Land Title Association boundary survey.

Utilities

If you want to be successful in your quest for a land loan, your best bet is to go with property that is incorporated. This means that there is access to utilities including sewage, electricity, and water. There are also road requirements that vary according to the lending institution (i.e., paved, private, etc.). If the land you want to build on is missing any of these features, you’ll need to draw up a detailed plan that includes a budget, permit types and how you’ll get them, and any other governmental codes and statutes that you’ll need to follow.

Zoning & Restrictions

Not all land is zoned for all types of property. Make sure that the land you plan to build your home on is zoned for residential use. Although this matter is generally taken care of well before construction begins, you do not want to risk beginning your project only to have it administratively paused due to failure to adhere to local zoning laws. Also, make sure to do your due diligence regarding any additional rules for the location of your land and the overall scope of your project.

Wildlife & Environmental

Depending on the state where you intend to build, there may be certain environmental regulations that will prohibit certain types of development. You should check with both your state and the U.S. Fish and Wildlife Service to ensure that you are not planning to build in an area with restrictions or that may cause undue harm to protected animals and plant life.

However, in some jurisdictions, you may qualify for government grants if your development will serve to protect endangered species or support the environment in the course of construction. These plans will need to be included in your application materials.

Future Changes

Development is a constant event, especially in more urban areas. If you know that there will be other projects happening near the land where you hope to build (such as new retail centers, schools, or highways), that needs to be factored into your plans, as well. City redevelopment projects can affect the value of your land and the bank will likely want to factor that into your loan application.

Top Lenders for Land Loans

Usually, if a lending institution offers conventional mortgages, they will also offer land loans; at the very least, they should be able to guide you on the process of obtaining one. Here are a few of the top lenders in the industry that offer different types of loans. Remember to do your own research, too, and also check out banks and other lenders near you so you can find the best deal for your situation.

1. PrimeLending offers a construction loan to build the property and then will refinance the loan into a traditional mortgage at the most favorable terms that the borrower qualifies for, including a fixed rate and interest-only payments in the construction phase.

2. Chase offers loans on second homes, but according to Natalie Johnson, a Dallas-based MLO, they do not offer land loans. Furthermore, the second home must already be erected before applicants can be granted a mortgage.

3. New American Funding has an ADU (accessory dwelling unit) loan product that allows homeowners to build a secondary structure onto their property. Borrowers who want to build a guest house, in-law apartment, or similar unit may benefit from this loan product.

4. Quicken Loans only offers construction loans to builders for development projects.

5. Horizon Farm Credit specializes in rural land. They offer bare land loans, and timber and forest land loans.

Frequently Asked Questions About Land Loans

What Are the Differences Between a Land Loan & a Home Loan?

A land loan is more complex than a mortgage loan, and is also riskier. Where an existing home acts as collateral the bank can use to feel more secure that the borrower will make their payments, land does not offer that same protection. So, interest rates on land loans are generally higher than those for mortgage loans.

Another difference lies in the loan repayment terms – land loans tend to be much shorter than mortgages. While a mortgage may be for 30 years, land loans are typically five years at various rate types (i.e., fixed or adjustable) with a balloon payment at the end. However, companies such as Horizon Farm Credit, who specialize in land loans, offer terms up to 15 years.

Down payments are another area where loan types differ. Traditional mortgage loans can require anywhere from 3% to 20% for a down payment. For land loans, however, the down payment can range from 20% to 50%. Again, this is due to the risk that lending institutions incur once they approve and fund the loan.

Why Are Land Loans Seen as High-Risk?

Without a structure on the property, borrowers are more likely to default on their loan. For example, if a home is on a plot of land where the borrowers already live, they are more inclined to keep up with the mortgage payments in order to maintain their place of residency. In the view of many lending institutions, borrowers could more easily default on an empty plot of land because there is no investment there. This is the primary reason that many banks do not offer land loan products.

What Are the Typical Down Payment and Loan Terms for Land Loans?

Down payment requirements for land loans begin at 20% and can reach 50%, and the typical cap for land loan repayment terms is 15 years. And as of late 2022, borrowers could expect to pay about 7% interest on land loans.

Can I Use Equity in Land I Already Own for the Down Payment and Closing Costs?

According to Mount Joy Loan Officer, Rhiannon Levan, you can use the equity in land you already own for the down payment on new land: “Taxes and insurance would still need to be paid out of pocket at time of modification, but we are able to use any equity in the property owned for down payment. This especially comes in handy for customers who are given/gifted land that was subdivided from a family farm.”

It should be noted that the land that will be used as equity for the new land or construction loan should be paid off and free of any liens at the time of application. The value of your current land will also be a factor, as will your creditworthiness and debt-to-income ratio at the time of the application for a new loan.

Is It Cheaper to Buy Land and Build a Home?

Generally, no. Land loans are often more expensive due to the lack of collateral mentioned earlier. When you start to add the cost of the loan (principal + interest), construction costs, costs associated with getting the property up to code (i.e., utilities, private roads, etc.), materials, the home loan, and other associated obligations, it may be more financially sound to purchase an already existing home. In addition to development expenditures, most people will wind up paying for rent or a mortgage elsewhere while the new home is under construction.

Time is also an investment that can be equal to or greater than money. Construction can take a year or more and, in the process, there can be a lot of lag time between applying and getting approved for things like permits, installation of infrastructure (i.e., septic tanks and wells), professional consultants such as architects, and even government officials.

Prospective homebuyers who are interested in building from the ground up are encouraged to be realistic about the value of their property instead of assuming that their new home will be worth at least the cost of the construction. It is important to remember that the home will have an appraised value that may or may not measure up to the financial investment the homeowner has put into it.

Can I Buy Land and Build a Home With One Loan?

There are both private financial institutions and government loan programs, such as the USDA, that offer the opportunity to buy land and build a home with one loan. Often referred to as a C2P (Construction to Permanent) Loan, this loan type is modified after construction is completed.

Under the terms of the USDA program, your land loan and construction loan become your long-term mortgage loan after completion; in essence, rolling three loans into one. This loan covers several of the costs associated with building a home including contingency reserves, inspection fees, and builder’s risk insurance. However, you must be an eligible borrower with plans to build on rural land.

At Farm Credit, their C2P loan product involves determining the appraised value of the home based on your construction contract and blueprints. The lender will then loan up to 80-95% of that value depending on which program is used. While the home is in the building phase, the borrower will make payments based on the amount that has been drawn against the project. Once the construction is complete, the loan will be modified, and the interest rate may be lowered at that time.

Although C2P Loans are available, they are hard to find. Depending on the lender, they can also take more time than is desirous to the borrower because of all the players involved, including multiple underwriters, insurance agents, and appraisals. The USDA estimates a minimum of 220 days for construction, and borrowers must make six on-time payments before refinancing to lower the interest rate can take place.