Land Loans: Everything You Need to Know

The process of obtaining a land loan is trickier than obtaining a mortgage

A land loan is a type of credit that is used to finance the purchase of a plot of land. It’s sometimes called a lot loan.

You can take out a land loan if you’re interested in buying a piece of land to build a home. You can also use this type of loan to buy land to use for business purposes. The type of loan you take out, and how easy it is to qualify, will depend on where you buy land and how you intend to use it.

Key Takeaways

  • Getting a land loan creates a different set of challenges from applying for a mortgage on a house.
  • For example, because lenders require surveyed boundaries, you’ll need to check zoning and land use restrictions on the property, as well as access to utilities and public roads.
  • A build-ready lot will lower your borrowing cost compared with one that is not.
  • Other potential financing options include seller financing, local lenders, or a home equity loan.
  • Rural land may qualify for a U.S. Department of Agriculture (USDA) subsidized loan.

What Is a Land Loan?

If you buy land rather than an existing house because you want to build from scratch, you’ll probably need a land loan. This type of loan can be used to finance your purchase of a lot of land, whether for residential or business purposes.

A land loan is typically a more complex type of loan than a standard mortgage. For one thing, there’s no home to act as collateral for the land loan, and you can’t (usually) buy land with no money down. There are also several different types of land loan, designed to facilitate different uses for a land lot.

How Do Land Loans Work?

In general, a land loan works similarly to a standard mortgage. If you are approved for this type of loan, your lender will provide you with funds to buy your chosen lot of land. You will then pay them back, with interest, over the next years or decades.

However, qualifying for a land loan can be more difficult than getting a regular mortgage, because they are riskier for lenders. As a result, borrowers may have to prove that they have a good credit score (700 or above), and will have to explain what they intend to use the land for.

Borrowers may also highlight aspects of the property that need to be checked, like zoning, land use restrictions, surveyed boundaries, and access to utilities. These factors will give lenders an idea of how risky the loan might be. Once all factors have been taken into consideration, the rates and obligations of the land loan can be issued. Land loan interest rates tend to be higher than standard mortgage interest rates, but a good credit score and low debt-to-income ratio can lower the cost.

Land Fundamentals

There are several up-front challenges regarding land, especially raw plots that are not clearly defined. To ensure that you’ll be able to utilize the land as you intend, research the following items to adjust your plans accordingly.

Boundaries

First off, it is essential 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.

Zoning

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

Access

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

Because buying land is different from purchasing a home, it’s a good idea to work with a real estate agent who specializes in this type of transaction or construction loans.

Planned Use of Land

Lenders often do not like risk, and the act of buying land to further develop it can be a risky endeavor. However, depending on how you plan to use your land and when development will occur, the lender is more or less likely to assess risk to your loan.

Build Immediately

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 a current house gives the bank immediate, tangible collateral. However, developing a building immediately often has less risk than developing the land later, as there are more variables that may prevent development in the future.

The Federal Deposit Insurance Corp. (FDIC) has established lending policies issued to institutions regarding the loan-to-value limitations for land. All loan terms are up to each lender’s internal limits but should not exceed FDIC guidelines. Construction of a one- to four-family residence calls for a 15% down payment (or 85% loan-to-value limit).

Improvements Needed

Some land may not yet be ready to be developed on. This might have been known at the time of purchase, or it might not have been discovered until after the acquisition has been made. In either case, there is more risk surrounding the land as further uncertainties may cause escalating prices or further complications for developing an asset. The FDIC loan-to-value limit is 75% for land development, often requiring a deposit of up to 25%.

Speculative Investment

Finally, there is 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 subdivision with a convenient commute into the city. The land could then be sold to the developer for a tidy profit. Although the FDIC loan-to-value limit is 65%, lenders may feel compelled to require down payments greater than 35%.

Unimproved lots are ones that do not yet have basic required services. It is common to run into unforeseen problems and cost overruns, which can add months to the purchase time line.

Other Land Loan Financing Options

Given the above problems, you may need to search further to finance your land purchase on acceptable terms, and there are a few sources that you can try.

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 banks and credit unions typically look more favorably on land loans than the banking behemoths. 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 and personal financial information to prove creditworthiness.

Land Loan Pros and Cons

Pros
  • Land loans can be useful to small businesses connected to land.

  • Government programs like USDA loans may provide land buyers with affordable interest rates and very little or no money down.

  • Ready-to-build lots may be less expensive in some area codes than purchasing a new home.

Cons
  • Not all lenders offer land loans.

  • You have to get a survey and review the zoning rules to present to a loan officer for a land loan.

  • Some land loans have shorter repayment periods.

  • If you use your primary residence as equity on a land loan and default, you could lose your home.

USDA Loan

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

Home Equity Loan

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.

Is it difficult to get a land loan?

Getting a land loan is more difficult than obtaining a traditional mortgage because buying land isn’t as straightforward as buying a home. Many banks and credit unions do not easily offer land loans, so you have to be very specific about the land you are going to purchase, and be prepared to provide surveys and zoning information about the land on which you wish to build.

Is owning land a good investment?

Owning land can be a good investment depending on the land, its location, and how you plan to use it. For example, purchasing a plot of ready-to-build land as a primary or secondary home has a different degree of risk from purchasing a piece of raw land intended for farming.

What is the first step to applying for a land loan?

The first step to applying for a land loan may be locating the right lender for your purchase. Not all lenders offer land loans, but plenty are out there. A local credit union might be a good fit if you are going to work to develop land in your community. You will need to gather all of the paperwork, including a land survey, and information on how you plan to use the land.

How do you finance a land purchase?

There are several options. One is a land loan. However, you may also qualify for seller financing, local lenders, or a home equity loan. It’s worth exploring each option before you commit to a loan.

The Bottom Line

Financing a property on which to build your dream home is much more complex than applying for a mortgage. Lenders require surveyed boundaries, and you’ll need to check the zoning and land use restrictions, as well as access to utilities and public roads. The more improved the land, the lower your required down payment and borrowing costs will be.

The best options to finance a land purchase include seller financing, local lenders, or a home equity loan. If you are buying a rural property, be sure to research if you qualify for a USDA subsidized loan.

Article Sources
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  1. U.S. Department of Agriculture, Farm Service Agency. “Farm Loan Programs.”

  2. Federal Deposit Insurance Corp. “Loans,” Page 22.

  3. Consumer Financial Protection Bureau. “What Is a Home Equity Loan?