If you’re interested in purchasing land for commercial development, residential building, or agricultural purposes, there are several considerations to be made when financing the project. A land loan is a specific type of mortgage that allows you to purchase and finance the cost of vacant land. We’ll show you what you need to know about taking out a land loan so you can make an informed decision about how best to finance your land.
What Is a Land Loan?
A land loan is a special type of mortgage used to purchase raw or undeveloped land. These loans come with higher interest rates and shorter terms than traditional mortgages. Lenders also impose more rigorous credit score and income requirements for land loans than for other real estate financing tools.
Land loans are also known as construction loans or lot loans, as they’re typically used to finance the purchase of large parcels of land for development. For example, if you want to build a new home on an empty lot or construct a commercial building, you will likely need a land loan first.
How Land Loans Work
Land loans are very similar to other types of non-conforming real estate financing. These loans typically require a larger down payment than home loans, often as much as 20% to 25%. They also come with higher interest rates and shorter repayment periods—sometimes just five years or less. This is because, in many cases, lenders cannot sell these loans to government loan sponsors like Fannie Mae. Instead, they sometimes have to hold the loans themselves, which increases their risk.
It’s also important to remember that land loans are often just the first of multiple loans for a single project. The first is the short-term loan, which you use to purchase the land upfront. After the borrower repays that loan, they must obtain a second, longer-term loan secured by the land and helps finance construction costs associated with developing the property.
Qualifications
Many government mortgage sponsors, like Fannie Mae, do not guarantee loans secured by raw land. As a result, these loans are typically less standardized than conventional loans. The qualifications for a land loan ultimately depend on the lender and the purpose of the loan. However, there are a few qualification requirements that lenders commonly impose.
- Credit score. Most lenders require borrowers to have good credit scores to qualify for land loans. If your credit score isn’t at least 680, you may only be able to get financing through a government-sponsored program like FHA loans.
- Financial history. A borrower’s financial history is taken into consideration when applying for a land loan. Lenders want to ensure borrowers have a strong history of repaying loans on time and haven’t recently filed for bankruptcy.
- Down payment. A larger down payment is often required for land loans due to their higher risk. While most acquisitions require down payments of 10% or more, land loans often require 20% to 25%, except for sponsored programs for developing single-family residences.
- Income. A borrower must also demonstrate that they have a steady income or other financial resources to cover carrying costs and potential losses should the land not be developed as expected. Lenders also consider the borrower’s debt-to-income ratio, which represents the percentage of a borrower’s monthly income that is used for servicing existing debts.
- Proof of ownership or sale agreement. Before extending financing, lenders need to ensure there are no other liens on the land being financed. You’ll also need to provide a copy of your purchase agreement to establish ownership as part of the verification process.
- Due diligence, including an environmental survey. It may be necessary to have a survey done as part of your loan application. Likewise, the lender may request evidence the land can be developed. This may mean checking local zoning regulations or reviewing the historical use of the property to ensure there’s nothing that could stop you from developing the parcel.
Land loan rates
Land loan rates generally range from around 4% to 6% or higher based on the loan term and your specific credit risk. However, interest rates on land loans vary based on several factors, including the lender, your credit score and income, and the type of land you are purchasing. It is important to shop around for different lenders to find one that offers the best terms and the lowest interest rate.
Types of Land Loans
Raw land loan
A raw land loan can be used to purchase raw land that hasn’t been developed. This form of financing typically comes with higher interest rates and requires a larger down payment than other types of land loans. Raw land loans are typically used for agricultural operations or for investors buying land to subdivide and sell to individual developers.
Unimproved land loan
An unimproved land loan is financing used to purchase land that is not yet developed but that may have some basic improvements like roads or sewer lines. These loans usually come with better interest rates than raw land loans and may require a smaller down payment.
Improved land loan
This type of loan is used to purchase an acreage or parcel of land that has already been improved, such as a property with a house on it. It is typically easier to qualify for than a raw land loan and will require a smaller down payment. Depending on the property being acquired, these loans may be conforming loans, which gives borrowers the most options in terms of down payment and repayment terms.
Construction loan
This type of loan can be used to finance the purchase of land, as well as the construction costs associated with developing the land. These loans are complex and come with higher interest rates, so carefully review the terms and conditions before signing.
How to Get a Land Loan
The process for applying for a land loan varies by lender. However, the first step in getting a land loan is usually to research different lenders and determine which offers the best terms and lowest interest rate. Be sure to compare fees, repayment options, and any other associated costs. It may also be helpful to check your credit score to estimate better the rate you’re likely to qualify for. If there are any errors on your credit report, take the opportunity to dispute them and, if necessary, wait for your score to improve.
Once you choose a lender, gather all the documents you’ll need as part of a loan application, such as proof of income, financial statements, and identification. You may also need to provide proof of ownership or a sale agreement for the land.
When you are ready, contact your chosen lender and apply for the loan. If approved, you will be required to sign an agreement outlining all of the terms and conditions before the loan can be funded.
Pros and Cons of Land and Lot Loans
Pros
- Allows you to purchase raw or undeveloped land for development
- Can be used to finance large parcels of land, saving cash to cover improvement costs
- Can help you build equity quickly
- May offer tax advantages
- Flexible terms and conditions can sometimes be negotiated with lenders
Cons
- Higher down payment requirements than traditional mortgages
- Higher interest rates than other loans
- Shorter repayment periods than traditional mortgages
- Longer approval times due to the complexity of the loan process
- May require additional collateral for security
- Can be difficult to exit if you don’t complete improvements
- May require additional insurance to protect against natural disasters and other risks
Land Loan Alternatives
If you’re looking to purchase land but are struggling to secure a land loan, there are several alternatives that might be more appropriate for your particular financial situation. Home equity loans, which use the value of a home you already own as collateral, and seller financing, wherein the current landowner allows extended payment options, can both be excellent land loan alternatives.
If you plan to use land to secure a construction loan, consider paying cash for your raw land so you can pledge it as collateral for a construction loan. If you finance the land, you may not be able to use it to secure a construction loan later.
Frequently Asked Questions
Is it hard to get a loan to buy land?
It can be difficult to get a loan to buy land because lenders typically require a larger down payment for a land loan than for a home loan, and the interest rates are higher. The amount of collateral required may also vary depending on the type of land you’re looking to purchase. Check your credit score before applying and provide proof of income or other financial resources when applying for a land loan to increase your chances of approval.
Additionally, researching the land before purchasing it is essential to ensure it meets any development plans you may have in mind. By understanding all the factors involved in obtaining a land loan and researching available alternatives, such as home equity loans or seller financing options, you will significantly increase your chances of getting approved for this kind of financing.
What is a good credit score for a land loan?
A credit score of 700 or higher is typically a good credit score for a land loan. A higher credit score will help you get better terms on your loan and may even help you qualify for lower rates. Lenders may look at other factors such as income, financial resources available, type of land being purchased, and repayment capacity when determining what kind of interest rate to offer.
To get the best deal possible, shop around with different lenders for the best rate. Having collateral or securing additional insurance can also increase your chances of getting a favorable loan agreement. Also make sure that the land meets all your development plans before committing to purchase it so that you don’t face unexpected costs down the line.
What is the lowest down payment for land?
The lowest down payment for land typically varies depending on the type of loan you are applying for, the amount of collateral available, and your credit score. Generally speaking, lenders require a minimum of 20% down payment when financing land purchases. However, this requirement may vary depending on factors such as loan type and credit score.
It is possible to get lower down payments if you have current assets or additional collateral that can be used to secure the loan. The same is true of government-sponsored construction loans, such as those offered by the Federal Housing Authority (FHA). Seeking creative financing solutions such as home equity loans or seller financing options can also help you find a way to finance your land purchase without putting up too much money upfront.
