Everything You Need To Know About Land and Build Loans

Buying land and building a custom home from the ground up is an exciting prospect for many prospective homeowners. However, it also comes with its fair share of challenges, especially when it comes to financing. Land and build loans are a great option that allow you to buy land and construct a new home in one fell swoop. In this comprehensive guide, we’ll walk through everything you need to know about these unique loans so you can determine if they are the right choice for your situation.

What Exactly Are Land and Build Loans?

A land and build loan, also sometimes called a construction-to-permanent loan, combines the financing to purchase land and construct a new home into a single loan. Rather than taking out separate loans for the land purchase and construction, it wraps it all up into one. This can greatly simplify the process.

With a land and build loan, you are able to use the funds to buy the lot and then pay for all construction costs as you build the home. Once construction is finished, the loan converts into a traditional long-term mortgage. This means you only have to go through one loan application process and pay closing costs once.

Land and build loans are offered by some banks, credit unions, and mortgage lenders, though not all lenders provide these specialized loans. They also come in a few different forms:

• FHA construction-to-permanent loan: Insured by the Federal Housing Administration (FHA), this option offers low down payments and flexible credit requirements.

• VA construction-to-permanent loan: Backed by the Department of Veterans Affairs (VA), this type is for eligible military members and does not require a down payment.

• USDA construction-to-permanent loan: Guaranteed by the U.S. Department of Agriculture (USDA), this is designed for low- to moderate-income buyers in rural areas.

• Conventional construction-to-permanent loan Offered by private lenders and backed by Fannie Mae or Freddie Mac These typically require higher credit scores and down payments than government versions

Pros and Cons of Land and Build Loans

Land and build loans offer some nice perks but also come with a few potential drawbacks to keep in mind. Here are the key pros and cons

Pros:

• One loan for land purchase and construction
• Typically only one set of closing costs
• Can provide low or no down payment options
• Lock in one interest rate upfront
• Make just one monthly payment

Cons:

• Limited availability and can be hard to find
• Require strong credit and high debt-to-income ratios
• Involve variable rates during construction
• Higher interest rates than traditional mortgages
• Time-consuming application and approval process

As you can see, land and build loans simplify the financing process. But you need pristine credit and financial credentials to qualify. And shop around, as these loans are not common.

Land and Build Loan Requirements

Since land and build loans blend two major transactions into one, lenders impose strict requirements to mitigate their risk. Here are some common eligibility standards:

• Credit score: Most lenders require a minimum score around 640 to 680
• Down payment: Typically at least 5% to 20%
• Debt-to-income ratio: Usually a max of 43% or less
• Loan-to-value ratio: Lenders prefer 80% LTV or lower
• Income verification: Expect two years of W-2s, paystubs, and tax returns
• Construction timeline: Build must be completed within 12 months
• Home type: Usually limited to single-family homes

Requirements vary by lender and down payment assistance programs may be available. But you can expect to need top-notch credit, steady income, low debt, and ample savings.

How Do Land and Build Loans Work?

Land and build loans have a multi-step process that differs from standard mortgages. Here is a general overview of how they work:

1. Get pre-approved: Work with a lender early on to get pre-approved and verify you meet eligibility standards. This helps ensure you qualify before you buy land.

2. Find land: Once pre-approved, start shopping for land in your preferred area that fits within your budget. Keep lender requirements for the location and property type in mind.

3. Make land purchase contract: When you find the perfect lot, make an offer and enter into a purchase agreement contingent on securing financing.

4. Finalize land and build loan: With the purchase agreement in place, your lender will finalize approval and provide loan documents to close on the land purchase.

5. Start construction: After closing, you can break ground! Your lender will manage payouts to the builder during construction based on inspectors verifying completion of project milestones.

6. Construction completes: When your home is finished, the loan converts to a traditional mortgage and you move into your new custom home!

It takes coordination, patience, and diligent financial planning. But the end result is your dream home on your own land.

What Are Current Land and Build Loan Rates?

Land and build loans typically come with higher interest rates than standard mortgages. This accounts for the increased risk lenders take on with these products. Here are current rate ranges:

• FHA: 4.5% to 5.5%
• VA: 4.25% to 5.25%
• USDA: 4.75% to 6%
• Conventional: 5% to 6.5%

These rates are on the higher end compared to traditional 30-year fixed mortgages, which currently average around 3.5% to 4%. But once construction is complete, you may be able to refinance to a lower rate.

Always compare options from multiple lenders. And remember, you’ll lock in one rate upfront that covers both the land purchase and construction.

Mistakes to Avoid With Land and Build Loans

While enticing, land and build loans do come with risks and pitfalls if not approached carefully. Here are some common mistakes to avoid:

• Not getting pre-approved early enough
• Overpaying for land
• Starting construction before full loan approval
• Choosing a builder not approved by your lender
• Not budgeting properly for unexpected overages
• Not having financing to cover cost overruns
• Failing inspections that delay draws and payouts
• Not fully understanding the loan guidelines and timeline

Working closely with your lender and builder from start to finish is essential to avoid missteps. Don’t assume you qualify or understand all the fine print. Seek guidance to ensure smooth sailing.

Alternatives to Land and Build Loans

If you find that land and build loans don’t work for you, here are a couple alternatives to consider:

Separate construction loan + mortgage: Rather than combo financing, you can opt to take out a short-term construction loan for just the building costs and then get a standard mortgage for the completed home.

Owner-builder construction: If you have construction experience, you may be able to act as an owner-builder to save on labor costs and qualify for an owner-occupied mortgage once the home is done.

Personal loan: Consider a personal loan to purchase land separately, then pursue a construction loan or cash to build. The benefit is that personal loans have fewer eligibility requirements than mortgages.

Renovation loan: An FHA 203(k) or homestyle renovation mortgage allows you to buy and remodel an existing home on one loan. This avoids some hassles of new construction.

Carefully weigh all your options to find the most viable path for your situation. Don’t jump into land and build financing without exploring alternatives too.

Finding the Right Land and Build Lender

Land and build loans require an experienced lender who offers these niche products. Here are some tips for picking the right one:

• Ask friends, realtors, builders for recommendations
• Search for “construction-to-permanent loans”
• Look for lenders who advertise these loans upfront
• Ask about their specific qualifications and requirements
• Inquire about their construction payment procedures
• Compare interest rates and closing costs from multiple lenders
• Verify they have the financial capacity to fund construction
• Choose an established lender with a strong local reputation

It takes extra research and vetting to find the right lender for a land and build loan. But taking the time upfront is well worth it for a smooth process.

The Bottom Line

Land and build loans let you buy land and construct a custom home through simplified financing. While enticing for diehard do-it-yourselfers, they aren’t for everyone. You need sparkling credit, a substantial down payment, a meticulous budget, and the patience to see it through.

If you’re willing to take the plunge into building your own home from the ground up, land and build loans can be a great option. Just go in armed with eyes wide open to the process, risks, and requirements involved. And surround yourself with experienced professionals who can help guide you through this exciting journey.