Land Loans: 3 Things to Know Before You Buy Land

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

If you buy land rather than an existing house because you want to build from scratch, you'll probably need a land loan. This raises more problems than getting 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.

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

Key Takeaways

  • Getting a land loan creates a different set of challenges than 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 as compared to one that is not.
  • The best loan sources include seller financing, local lenders, or a home equity loan.
  • Rural land may qualify for a USDA subsidized loan.

Land Fundamentals

There are several upfront challenges regarding land, especially raw plots that are not clearly defined. To ensure you'll be able to utilize the land as you intend, ensure you 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 hook-ups ready to go save 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 such is not already available.

Because buying land is different than 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 Corporation (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 the basic required services. It is common to run into unforeseen problems and cost overruns, which can add months to the purchase timeline.

Land Loan 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 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 big 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 Loans Pros vs. 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 United States 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 you wish to build on.

Is Owning Land a Good Investment?

Owning land can be a good investment depending on the land and its location, and how you plan to use the land. For example, purchasing a plot of ready-to-build land as a primary or secondary home has a different degree of risk than 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 there are plenty 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 the paperwork, including a land survey, and information on how you plan to use the land.

The Bottom Line

Financing a property on which to build your dream home is much more complex than applying for a mortgage. Lenders required 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 Loan Programs."

  2. Federal Deposit Insurance Corporation. "Loans," Page 22.

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