If your goal is to build your dream home, buying land might be the first step. But land can be an expensive purchase to make in cash. If you want to buy land, but need to finance it, land loans are an option.
What Is a Land Loan?
Just as mortgages are for buying homes, land loans are for purchasing property without a home built on it. Land loans are typically secured by the property itself. So if you default, the lender may take ownership of the land in an attempt 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: How to Get the Best Possible Mortgage."
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. For example, repayment periods may cap out at 15 years, while mortgages can go for terms as long as 30 years or more. Land loans also may feature higher interest rates or require a down payment as high as 50%.
How and Where to Get a Land Loan
If you're applying for a land loan, you may need to consider a wider variety of lenders. Large national lenders and online lenders may not have the local knowledge necessary to assess whether a loan for a particular piece of property is a risky proposition, so they may not be as open to financing land as local lenders are.
Most often, the best places to get land loans are local or regional banks and credit unions. Having somebody local usually means you'll be working with someone who understands the market, says Melissa Terzis, residential real estate agent at RLAH Real Estate.
To get a land loan, you need to fill out 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 what 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 wildly depending on these factors.
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"There are things you're going to need to know about the property that you would just assume when you're buying a home," says Fleming. For example, a lender may ask whether the land has been improved, what the land is zoned for and whether the land can support the use you have planned.
The answers can make a big difference to the lender. If your land is raw and untouched, it presents a higher risk for the lender. "A piece of property that has utilities right at the property is much easier to get a loan on than something that doesn't," Fleming says.
Once you fill out the loan application and provide the lender with all necessary information, your loan goes through underwriting, where the lender decides to either approve or deny your application.
How to Find the Best Land Loan for You
Finding the best land loan is much like finding the best mortgage, but you have to use different tools to get the job done. Unfortunately, shopping for a land loan isn't as easy as shopping for a mortgage. Online tools that allow you to compare many loans in a short period of time aren't common for land loans like they are with mortgages.
Instead, you have to investigate which lenders in your area finance land purchases and compare the terms each lender offers yourself. "You always want to get (the offer) you're shopping around on paper so you can take it from place to place," says Terzis. In some cases, a lender might be able to match or beat a competing lender's 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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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. "In the beginning, you're only paying the interest on the purchase price of the land," says Terzis. These loans also allow for draws to help pay for construction costs until the house is completed, usually within 12 months from closing. "When the construction is done, then it converts to a permanent mortgage," she says.
-- Home equity loans. If you already own a home, you might choose to 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 is in excess of 20%. So, if you have 35% equity in your home, you could borrow against 15% of your home's value. These types of 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 terms of the loan 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. That said, these loans might work for you if the land you want to buy is inexpensive.