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 three things to consider before buying land.

Key Takeaways

  • Getting a land loan creates a different set of hurdles than applying for a mortgage on a house.
  • Lenders require surveyed boundaries, and you'll need to check zoning and land-use restrictions on the property, as well as access to utilities and public roads.
  • The more improved the land, such as a build-ready lot, the lower your borrowing cost.
  • The best loan sources include seller financing, local lenders, 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 raise property values in the coming years, while a new highway or sewage treatment plant is less likely to do so.

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.

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 required down payment will typically be in the 15% to 25% range. 

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. These loans may require a down payment of up to 50%.

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.

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 banks and credit unions 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 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.

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 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.