How to Get a Land Loan: Everything a Buyer Needs to Know
Traditional mortgage choices are plentiful, but what if you need to buy an empty lot, either to build your dream home or an office for your business? Land loans are significantly different than home or commercial mortgages in terms of financing options, costs and even finding a lender.
There are many ways to get land loans, but it can be difficult to figure out which one is the right fit. That’s why we developed this guide.
- What is a land loan?
- How to find a land loan
- Improved land versus raw land for building a house
- Construction loans for residential homes
- Financing options
What is a land loan?
A land loan isn’t always used to just buy raw land. Most often, these loans are used to purchase a vacant lot and also finance the construction of a structure, whether it be a home or business. Depending on your financial capabilities and the intent of how you want to use the land, it can be relatively easy or more difficult to get funding.
How to find a land loan
Where you’ll want to look for a land loan depends on what you want to do with the land. Generally, land loans are more difficult to find than traditional mortgages, says Robin Kencel, a real estate agent with Greenwich, Conn.-based Compass Real Estate. She says some lenders are cautious about issuing land loans. “If the loan is defaulted on, they need to sell that property to get the money back,” said Kencel, and it’s often more difficult to sell raw land.
With no structure yet built on the property, lenders may view these buyers as having less skin in the game. If construction plans fall through or the buyer no longer wants the land, the risk of default increases. This is why some lenders will offer mortgages, but not loans for raw land or construction loans. Simply put, land loans are riskier.
Kencel says she often recommends a specific bank or mortgage brokers to clients seeking land loans since brokers have a wider net for finding lenders. The type of lender you need depends on what you plan to build on the land or if you just want a vacant parcel to keep as an investment or develop later.
Mark Kraft, a regional mortgage manager for Minneapolis-based U.S. Bank in Denver, says that if you’re already working with a builder, they’ll know where you should look.
Raw land loans can also be found through specialized lenders (like those who specialize in farming loans), credit unions and smaller local lenders familiar with land in the area.
Improved land versus raw land for building a house
- Improved land: Land that has access to things like roads, electricity and water.
- Unimproved land: Raw land that doesn’t have access to these services. It needs to be inspected and can support things like a septic tank or be able to reach certain public utilities.
Unimproved land can require a substantially higher down payment than improved land. Construction on unimproved land often takes longer; you will likely have to do more clearing for utilities and roadway access.
Also take into consideration the size of the lot you’re looking to buy. Kraft says you can run into “acreage limitations” for the area because lots should be similar to other lots in the area. And it often helps to keep it compact: “The bigger the lot, the more problems you might run into,” said Kraft.
Construction loans for residential homes
After your land has been approved by the lender as being suitable for building, you’ll then need a construction loan. Construction loans pay for the land itself and the cost of the construction. They come in two types:
- Construction-to-permanent loans: Also known as all-in-one loans, this type of loan wraps the costs of construction and mortgage into one loan. You’ll make interest-only payments during the construction phase, and when the home is built, it will roll over into a regular principal-plus-interest mortgage payment like a traditional home loan.
- Stand-alone construction loans: This involves two separate loans: a short-term one used for constructing the home and a second loan used for the home’s mortgage. You’ll have to pay closing costs and go through the approval process twice.
Most construction loans require at least a 20% down payment. Construction loan terms vary by lender and interest rates may be slightly higher than regular mortgages. Kraft says some construction loans may require a 1% upfront fee of the construction loan cost. During construction, the lender pays the builder in draw periods. For example, the lender may pay out a certain percent of the loan after the foundation is poured and again when the house is framed. In all likelihood, you, the builder and your lender will decide on when these draw periods occur. It helps all parties to keep the construction schedule on track.
For more about the nitty-gritty about these two types, check out our guide on construction loans.
Financing options for building a home
Other than construction loans through traditional or nontraditional lenders, you may qualify for certain government programs to help you finance buying land and constructing a home. Here’s a quick overview of some land loan financing options.
VA construction loans
VA loans can’t be used to buy only land, but they can be used to finance construction loans. However, VA loans for both land and construction are quite hard to find. That’s why some qualified veterans will purchase a construction loan and, once the construction is complete, refinance the new home’s mortgage into a VA loan. However, this means putting money down for the construction loan and missing out on the little or no down payment option which makes VA loans so attractive.
Additionally, several rules can disqualify some land from being used. For example, the land can’t be over 20 acres or located in a noise zone, in certain flood zones and areas of geologic instability (like earthquakes). For an in-depth look at getting a VA land loan, check out our guide.
FHA construction loan
FHA construction loans are like regular construction loans but are backed by HUD, and they only come in the construction–to-permanent option (these are commonly known as FHA one-time-close construction loans).
If you can find a lender who offers FHA construction loans, you should be able to take advantage of FHA’s low down payment options — as low as 3.5% — for the entire construction-to-permanent loan. According to HUD, the borrower must be purchasing the land at the time of closing on the construction loan. In other words, the land purchase has to tie into the construction loan at closing.
While FHA loans typically have less stringent buyer eligibility requirements, it’s probable that a HUD-approved lender will need to see a significantly higher credit score and down payment than the minimum for a regular FHA mortgage. Unless certain exceptions are met, properties under construction are limited to a 90% loan-to-value ratio, although some borrowers may be eligible for higher. Borrowers with credit scores between 500 and 570 will need to pay 10% down, while those with scores 580 and above may be eligible for the 3.5% down payment. Remember that lenders have their own requirements for eligibility, so their standards can be higher than HUD’s. Read more about getting an FHA construction loan here.
USDA Guaranteed Loans
The U.S. Department of Agriculture guarantees loans from qualified lenders via its Single-Family Housing Guaranteed Loan Program. This loan is a single-close, construction-to-permanent loan which can be used to buy a lot of land, much like other loans we have described, although this program is for low- to moderate-income borrowers in rural areas. Income eligibility depends on location; you can check your area on the USDA website.
A minimum credit score of 640 is recommended as the USDA advises lenders to “perform a cautious level of underwriting” for borrowers with scores below that number. The maximum debt-to-income ratio for a USDA loan is 41%, and no more than 29% of your monthly income can go toward the mortgage.
Financing options for commercial buildings
If you have more commercial interests for your land and are interested in government programs that may help, the Small Business Administration is a good place to start.
SBA 504 loans
The SBA’s 504 loan program, also known as a Certified Development Company (CDC) loan, can be used to purchase land where you want to build your small business and construct new facilities.
The program is administered through nonprofit CDCs. A third-party lender provides at least 50% of the financing, the CDC provides up to 40% and you, the business owner, provide the final 10%. You can find a CDC near you by searching here. Your down payment costs can be even lower if your state, town or city is offering certain incentives, like down payment assistance, in order to attract more businesses.
SBA 504 borrowers may receive up to $5.5 million at terms ranging from 10 to 25 years, but they must have used other financial resources, including personal funds, before applying. Rates are determined when the loan is issued. Eligible businesses must be worth less than $15 million and you must have a net income no higher than $5 million after taxes for the two years before applying. You must also be able to repay the loan on time using the projected cash flow of your business.
SBA 7(a) loans
Another loan through the SBA, the SBA 7(a) loan, also allows for borrowers to buy land. SBA 7(a) loans offer up to $5 million for small business owners. All 7(a) loans require a 10% down payment, while larger loans (above $25,000) also require collateral. SBA 7(a) loans can range up to 25 years in length and can be fixed rate or variable rate.
While SBA 7as can be used to buy land for commercial real estate, the SBA 7(a) is a general use kind of business loan. With their typically larger down payments and the need for collateral may, it may be more beneficial to use the SBA 504 loan for commercial real estate deals.
Alternative financing options for your home or business
Using your own home equity
If you already have a house, you can take out a home equity loan to purchase land outright. However, this is a risky maneuver. You’re essentially securing the land with your home; if you can’t pay back the home equity home, you’ll lose your house.
Home equity loans come with closing costs of about 2% to 5% of the loan amount. The loan is typically a fixed-rate loan for 10 to 15 years, and you can borrow up to 85% of your home value in most cases.
The land seller may be willing to finance the land themselves. In this instance, the seller acts as the lender. You and the seller come to terms with the entire loan agreement, including interest rate and length. Expect to pay higher interest rates, and it might be a wise move to have an attorney look over the documents so you know exactly what you’re getting into since the seller is in charge of setting the rates and terms.
Getting land through teardowns
Another way to buy land is to purchase a property with a home already on it, and tear it down. “Getting a mortgage for land is easier when there’s a tear down on it,” said Kencel. She notes that lenders would rather give out loans for property that already has an existing structure — of course, you’ll have to tell them of your intent.
However, you should carefully weigh the pros and cons of buying a teardown for the land. Demolition costs money, and you’ll need to go through all the proper channels to receive the green light for tearing the place down — that includes building permits and getting the OK from your lender. You will also need to get your new build properly zoned, commercially or residentially, which can place limits on the location, size and height of your home or business. Additionally, the local community could object to the teardown, and you may have to follow certain long-standing architectural styles already in the neighborhood.
Additional costs and requirements
For construction loans, lenders aren’t just looking at your buyer profile — they’re also assessing the builder. “If I’m underwriting a [construction-to-permanent loan], I’m underwriting the builder. I need to know that builder is competent,” said Kraft.
Approval is also more difficult for construction loans as there isn’t a home or business to inspect and appraise. All the building plans, costs, fees and the feasibility of the building schedule will be closely considered. The builder’s previous work will likely be evaluated as well, so if your builder isn’t up to par, then your loan will be denied.
It’s important to keep an eye on the building process budget. If the budget grows beyond what the lender approved, the lender will probably require you to pay for it yourself or obtain a second loan to cover the cost. So don’t go adding golden toilets and crystal chandeliers (unless you budgeted for that).
Getting a land loan can be difficult and financing can be tricky. The difficulty of getting a loan to simply purchase raw land is often dictated by the market — if you’re in a hot market, some lenders may be more willing to loan you money because of increasing land value (and thus less risk of losing money should you default). And if the area you are in typically has homes in remote places, there’s likely to be a land loan lender for your needs.
Raw land whose value is speculative — meaning the borrower is hoping for some kind of rise in property values — often requires a down payment value of 50%. It’s important to clearly communicate with your lender what you intend to buy the land for. If it’s for building a home, having a good builder and the intent to build ASAP can increase your likelihood of getting a loan for land.
Finally, when you’re looking to secure a land loan, it helps to have a strong buyer profile — just like when buying a traditional home. Keep your credit score up, your debt-to-income ratio down and have the means for a healthy down payment.