Land Loans 101

All about Borrowing before Building

Land Loans 101
November 10, 2014

You are ready to buy a home, but you cannot find a home that has all the features that are important to you. However, you have found the perfect plot of land on which to build your own dream home. That means you will soon be entering the world of land loans – loans that are similar to mortgages but with some distinct differences.

Land loans are loans to buy property that is not currently being used for any home or business purpose, generally referring to undeveloped land. Land loans usually require larger down payments and will carry higher interest rates because they represent a larger risk for the lender. Without a house on the lot as collateral and no guarantee that you can complete the building of one, lenders will have difficulty dealing with the land if you default.

The terms “lot loan” and “land loan” can be used interchangeably, but there are differences. Lot loans generally imply that the property is in a platted development with roads and utilities, or at the very least, plans exist and have been partially executed. There may be acreage limitations or other distinctions that vary among lenders. When comparing rates, it is critical to verify these rules with each lender.

You will want to compare rates, and you should be prepared for higher down payment requirements – perhaps up to 50% of the lot’s value.

With fewer lenders in this market and varying definitions, comparison-shopping is even more important than with standard mortgage loans. You may have better luck with a local lender who has a better understanding of the local land market.

Before searching for a lender, take care of a few preliminary steps.

  • Check Your Qualifications/Financing – Not only are down payments and interest rates higher, but the required LTV (Loan-to-Value) ratios may be lower. Compared with the possibilities of mortgage loans that can approach 100% of the value, a 70% maximum LTV may be more likely for a land/lot loan.

    DTI (Debt-to-Income) ratio limits may be similarly offset for risk. Terms are often shorter, and may require balloon payments under the assumption that you will be shifting to a construction loan.

    Given these conditions, do you have sufficient cash and income to take out the land loan and proceed with construction at some future point? Otherwise, you will be stuck paying property taxes on land you are not using.

    Consider whether you are comfortable with providing additional collateral if the bank requests it – for example, a minimum deposit of some form of liquid assets with the bank, or cross-collateralization with your existing home or other land you may own.

  • Provide Plans – The more detailed your plans and the more that infrastructure is already in place, the more likely it is that you can find a land/lot loan at a reasonable rate. You have demonstrated your level of seriousness.

    Make sure that you have a detailed and complete survey in hand. Since the land is the only collateral existing in this case, the survey takes on great importance. In undeveloped areas, you will also need to verify zoning and the capability/costs of running utilities.

  • Investigate Options –Construction loans can be arranged as “Construction-to-Permanent” loans that effectively create a construction loan to be rolled over into a traditional mortgage loan after the construction is finished. The lot costs can be added into this, as long as the closing on the lot purchase can be coordinated with the closing on the construction loan.

    This is convenient for the buyer, yet tricky to coordinate and potentially costly. However, if you are ready to buy and build straightaway, this may make the most sense for you.

    Another alternative is seller financing for the lot, where the owner of the lot is financing your purchase directly. This can be advantageous but risky. Seek an attorney’s advice to make sure you have a solid contract in this case.

Land loans can be challenging, but are often well worth the effort. With planning and perseverance – and sufficient cash –, you can relax in your freshly constructed dream home, built on land you purchased through a land loan on your preferred terms.

If you are interested in a personal loan, visit our curated list of top lenders.

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