If you buy land, rather than an existing house, because you want to build from scratch, you'll probably need a land loan. And that raises more problems than getting a normal mortgage. For one thing, there's no home to act as collateral for the land loan.

Obtaining land financing creates a different set of hurdles for potential buyers. Here are some factors to consider before buying land.

Key Takeaways

  • Lenders need to have surveyed boundaries to issue a loan on land.
  • Check zoning and land-use restrictions on the property—also access to utilities and, public roads.
  • The more improved the land—a build-ready lot, unimproved lot, raw land—the lower your borrowing cost.
  • Best loan sources: seller financing, local banks, and credit unions, or a home equity loan.
  • Rural land may qualify for a USDA subsidized loan.

1. Land Fundamentals: Boundaries, Zoning, Access

First off, it is important to be clear on what the potential purchase entails. This is why it is vital to get the boundaries marked by surveyors and have everything on paper ready to be presented to the lender. Another important detail is to double-check zoning and land-use restrictions.

For residential lots, having access to utilities is a big factor. Having water, sewer, electricity and cable hook-ups ready to go saves a lot of time, money and hassle. Similarly, public road access can be a key issue, since the buyer will have to secure a permanent easement to access a public road if such is not already available.

It is also wise to check with the local planning department to find out what the future holds for the immediate neighborhood. A new park down the street can benefit property values in the coming years, while a new highway or sewage treatment plant is less likely to do so.

2. Planned Use of Land: Build Immediately, Improvements Needed, Speculative Investment

The terms of the loans, such as down payment and interest rate, typically hinge on the intended use of the land, since this is directly linked to the bank's risk exposure. In this way, getting land loans is always trickier than buying an existing house, since an existing house gives the bank immediate, tangible collateral, whereas new construction has more moving parts that can go awry.

From existing homes, the next step down on the bank's confidence ladder is buying a build-ready lot with the intention to start construction of a primary dwelling right away. There are things that could go wrong, cause delays or increase costs along the way, but the timetable is still manageable in the bank's eyes. The down payment is typically in the 10% to 20% range.

Unimproved lots are ones that do not yet have the basic required services and that still needs utilities set up. It is common to run into unforeseen problems and cost overruns, thus adding months to the timeline.

Finally, there is also raw land with no specific plans to build anything, which is basically a speculative investment. For example, a project in this vein could involve buying land in anticipation of the completion of a new freeway nearby. The hope would be that, when the freeway is completed, the land would be attractive for a developer to build a new, trendy subdivision with a convenient commute into the city. The land could then be sold for a tidy profit to the developer. These loans may require a down payment of up to 50%.

3. Land Loan Options: Finding Financing

Given the above problems, you may need to search further to finance your land purchase on acceptable terms. Try these sources:

Seller financing

This can be a good option for getting favorable terms, especially if the seller is eager to unload the land and the market is cool. Since this is an agreement between two private citizens, everything is negotiable, from the down payment to the interest rate. It is important to have the papers reviewed by an attorney before signing anything to avoid loopholes and unpleasant surprises for either party.

Local banks and credit unions

Local lenders typically look more favorably on land loans than the big behemoths do. They also may offer better terms due to their local knowledge of the property. All the same, a potential borrower will need to present a loan package with specs and plans for the land, as well as personal financial information to prove creditworthiness.

USDA loan

How can buyers purchase land if the banks and credit unions do not offer to finance? If the property is rural and agricultural, the buyer may receive federal aid. The USDA offers an assortment of subsidized loans with minimal requirements and advantageous terms.

Lend to yourself

A buyer with existing property and little debt may want to consider a home equity loan. This type of loan taps the equity of the existing property, granting much better terms than any regular construction or land loan.