Everything You Need to Know About Using a Construction Loan to Buy Land

If you’re looking to build your dream home, a construction loan is likely the best way to finance both purchasing the land and building a house While a traditional mortgage only lets you borrow to buy an existing property, construction loans provide funds specifically for building a new home from the ground up

In this comprehensive guide, we’ll cover all the key details on using a construction loan to buy land and build on it.

What is a Construction Loan?

A construction loan is a short-term financing option that provides funds to purchase land and pay for building costs The loan provides access to the money in stages as construction progresses.

Here are some key features of construction loans:

• Allow borrowing to buy land and finance construction costs
• Funds are disbursed incrementally as project milestones are met
• Typically variable interest rates and interest-only payments
• Short-term loan that is replaced by permanent financing once home is built

Construction loans give flexibility in accessing funds compared to a traditional one-time lump sum mortgage. You only pay interest on the amount withdrawn, saving money during the building process.

Can a Construction Loan Purchase Land?

Yes, a major benefit of construction loans is the ability to borrow money to purchase land or real estate to build on.

The loan provides all the financing you need to both buy property and construct a new home on it. This avoids the need for separate land purchase and construction loans.

As long as the land meets the lender’s criteria, a construction loan can be used to buy vacant property, land with an existing home to rebuild on, and more.

Construction Loan Requirements for Land

While construction loans finance land purchases, lenders do have requirements for the property being used as collateral. Here are some typical requirements for the land itself:

• Must be suitable for building – lenders want to ensure the property can feasibly support construction of your planned home. Factors like size, terrain, zoning, and permits are considered.

• Located in an eligible area – lenders often limit construction lending to certain locations and types of properties. Common requirements include rural land outside of city limits, sites with space between homes, etc.

• Clear title – the land must have a clean title history with no disputes over legal ownership. The lender will check for liens, easements, zoning violations, or other title issues.

• Appraisal – the land must appraise for at least the purchase price. Lenders want to confirm the property’s market value supports the loan amount.

• Down payment – typically 20% down is required. You may be able to use the land’s equity toward the down payment if you already own the property.

Meeting the lender’s land and location requirements is key to being approved for a construction loan to buy and build.

How Much Land Can You Buy with a Construction Loan?

The amount of land you can purchase will depend on factors such as:

• Appraised value – lenders base the loan amount on appraisals, typically up to 80% of the land’s value. Higher valuations mean you can buy larger, more expensive properties.

• Down payment – the larger your down payment, the less you’ll need to borrow, allowing you to potentially buy more land. At least 20% down is usually required.

• Loan-to-value limits – most lenders cap the loan amount at 80% LTV. With $50,000 down on $250,000 land, you’d hit this limit.

• Cost of construction – the land purchase amount plus estimated build costs cannot exceed the total approved loan amount.

You can maximize the land size by putting more down, selecting land below the lender’s appraised value limits, building a moderately priced home, and keeping within LTV constraints.

Buying Land and Building Separately

Instead of buying land as part of the construction loan, you can purchase property independently through other financing like:

• Cash purchase – if you can pay for land in cash from savings, inheritance, home sale proceeds, etc.

• Land loan – banks offer specific loans just for vacant land purchases if you don’t have cash

• Owner financing – some sellers provide owner financing for land sales, taking payments over time

Then, with the land owned free and clear, you’d only need to borrow construction costs through a loan focused strictly on building the home.

The benefit of this route is you don’t need to qualify for as large of a construction loan. But it requires two separate transactions and loans.

Construction vs Land Loans to Buy Property

If choosing to buy land separately, you’ll need to decide between a land loan and construction loan for financing:

Construction Loan

• Typically lower rates and fees

• One-time close option for land/construction

• More stringent lender requirements

• Variable rates that rise over time

Land Loan

• Specialized financing for vacant land

• Fixed rates with consistent payments

• May have higher rates/points than construction loans

• Not tied to building a home

Construction loans offer a streamlined approach if you plan to build right away. But land loans allow more flexibility if your construction timeline is uncertain.

Finding the Best Construction Loans to Purchase Land

The key is shopping multiple lenders to compare. Look for the best construction loans for your scenario based on:

• Land purchase options – some lenders specialize in buying land to build on, while others don’t

• Lowest rates and fees – construction loans have widely varying costs between lenders

• Loan amounts – find a lender that will finance the land purchase price you need

• Construction expertise – choose an experienced construction lender who understands the process

• Customer service – the best lenders have helpful loan officers who guide you through the complex process

Be sure to get multiple loan estimates and compare overall costs. A little time spent upfront can save thousands over the loan term.

Steps to Getting Approved and Buying Land

If you’ve decided a construction loan is the optimal way to purchase land and finance building your home, here are the basic steps:

1. Find the ideal vacant land or property to build on

Search for land that meets your criteria and the lender’s requirements. Hire professionals to verify suitability for construction.

2. Get preapproved for the construction loan

Apply with multiple lenders and compare options. This shows sellers you’re serious.

3. Make an offer and enter purchase agreement for the land

Factor in costs like surveys, title insurance, and appraisals into the offer price as needed.

4. The lender appraises the property and finalizes loan approval

They will validate the purchase price against the land’s appraised value before final approval.

5. Close on the vacant land purchase

The lender provides the funds to buy the land at closing. Now you can move forward with the build.

The Bottom Line

Construction loans open up home building possibilities by providing financing to buy land as well as construct a new residence. Just be sure to find the right lender who offers the land purchase option and get preapproved before making any property purchase. This ensures you can buy the ideal lot or land for your dream home.