Purchasing vacant land to build a dream home from the ground up is an exciting prospect for many homebuyers. But financing the land purchase itself can be tricky without an existing structure to use as collateral. This is where lot loans, also known as land loans, come into play.
In this comprehensive guide, we’ll break down everything you need to know about land loans, including:
- What is a lot loan and how does it work?
- Types of land loans
- Pros and cons of lot loans
- Qualifying for a land loan
- Interest rates and terms
- The lot loan process
- Alternatives to consider
- FAQs about land loans
Understanding the ins and outs of lot loans will help you determine if this type of financing is right for your situation. Whether you want to build a primary home, vacation property or development, let’s explore how land loans work
What is a Land Loan?
A land loan, often called a lot loan, is a mortgage loan used specifically to purchase a vacant plot of land Without an existing structure on the property, lenders consider land loans riskier than standard mortgages But these loans make it possible to buy land you’ll use for building a residential property or commercial project.
Land loans function similarly to traditional mortgages in that you borrow money from a lender and pay it back over time with interest. The land itself serves as collateral for the loan. The typical repayment term is 5 to 15 years.
Down payments for land loans also tend to be higher, often 20% or more of the purchase price. And interest rates are usually 0.5 to 1% higher than rates for a home purchase loan. Despite slightly tougher terms, a land loan can provide affordable financing to make your development dreams a reality.
Types of Land Loans
There are a few different categories of land loans to be aware of:
Raw land loans – For purchasing completely undeveloped land with no utilities or access. This type of lot loan is the most challenging to obtain.
Partially improved land loans – For land parcels that have some utilities or grading but aren’t build-ready yet. Easier to qualify for than raw land.
Fully improved land loans – The most readily available type of land loan for properties with all utilities, access, grading, and permits in place.
The less developed the land, the harder it will be to get funding. Raw land loans have higher rates and fees. But even bare land can be financed with proper planning.
Pros and Cons of Land Loans
Lot loans offer distinct advantages, but also have some downsides to weigh. Let’s look at the biggest pros and cons of using land loans.
Pros
- Build your dream home from scratch
- Potentially lower purchase price for vacant land
- Lock in a fixed interest rate
- Tap into land equity over time through refinancing
Cons
- Higher interest rates than standard mortgages
- Larger down payment requirements
- Risk of project delays or cost overruns
- No existing structure to provide value
As with any major financing decision, it’s critical to assess both the benefits and drawbacks when considering a lot loan. Speak with a loan officer to determine if this type of lending aligns with your goals.
Qualifying for a Land Loan
Qualifying for a vacant land loan is more stringent than getting approved for a conventional home loan. Here are some key requirements to meet:
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Down payment – Expect to put down 20-25% or more on a land loan. Some lenders may accept as low as 15%. The higher your down payment, the better your chances for approval.
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Credit score – A minimum credit score of 620-650 is generally required, but scores of 700+ are ideal and will get you the best rates. Having little credit history can also disqualify you.
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Debt-to-income ratio – Your total monthly debt payments, including the new loan payment, should not exceed 43% of gross monthly income in most cases.
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Loan purpose – Lenders will want to see detailed plans for how you intend to use the lot, with timelines and cost estimates.
Meeting as many of the above criteria as possible will put you in the best position to get approved and get a competitive interest rate on your land loan.
Interest Rates on Land Loans
Interest rates on land loans tend to run 0.5 to 1 percentage point higher than conventional mortgage rates. This accounts for the increased risk lenders take on without an existing structure on the property.
For example, if current mortgage rates are averaging 6%, expect land loan rates around 6.5 to 7% for a buyer with good credit. Rates will vary based on your credit score, income, debt levels, and the status of land improvements.
Get rate quotes from multiple lenders to find the best deal. Consider both local banks and national lenders to shop and compare. Online lenders may also offer decent rates for land loans.
Land Loan Terms
The repayment term on a land loan is usually between 5 and 15 years. Longer terms of 20-30 years may be available, but will come with higher rates. You’ll pay more interest over the life of the loan with an extended term.
Aim for the shortest term you can reasonably afford based on the monthly payment. This minimizes interest costs over the life of the loan. You can always refinance later into a new land loan or standard mortgage once you complete construction.
Most land loans are structured as fixed-rate mortgages, meaning your interest rate stays constant over the full loan term. This guarantees predictability in your monthly payments. Adjustable-rate mortgages are riskier for land buyers, as rates could spike before you build.
The Land Loan Process
Here is an overview of the basic process to get approved and close on a vacant land loan:
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Identify the property and make an offer contingent on financing.
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Select a lender and complete their loan application detailing your plans for the lot.
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Provide required financial documentation to verify income, assets, and credit history.
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Obtain an appraisal of the land value.
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Receive loan approval and initial disclosures for review from the lender.
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Negotiate any necessary contract contingencies or corrections during the underwriting process.
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Schedule the closing once the land loan is cleared to fund.
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Finalize purchase and make arrangements to take possession of the vacant property.
Be sure to communicate closely with your loan officer throughout the land loan process. They can guide you smoothly through each step.
Alternatives to Land Loans
Land loans give you direct financing to purchase vacant property. But they aren’t your only option. Here are a few other ways to buy land without taking on as much debt:
Save up a large down payment – The bigger your down payment, the lower your loan amount and monthly payments will be. Save aggressively for even just 20% down.
Explore owner financing – Some sellers may be willing to act as the lender and collect payments over time. This avoids bank qualifying. But still have a lawyer review.
Use a home equity loan – Tap the equity in your current home with a lump-sum home equity loan or line of credit. Pay off the loan once you build.
Partner with co-investors – Pool money with business partners, family, or peers to purchase the lot outright with cash. Then split proceeds later.
Buy an existing property to redevelop – Purchasing a dated home to demolish or renovate can offer a lower entry point than vacant land in some markets.
Frequently Asked Questions About Land Loans
Can I get a land loan for a primary residence?
Yes, land loans can be used to purchase a lot for building a primary home. Second home and investment property construction is also permitted. Disclose your exact plans to the lender up front.
How much land can I buy with a land loan?
Most land loans cover 5 to 20 acre parcels, but some lenders will do loans for plots of up to 50 acres. The size and price of the land will impact your loan amount eligibility.
Should I get pre-approved for a land loan?
Getting pre-approved is highly recommended so you know your price range and can make competitive offers. The seller will also want to see you are qualified with a lender.
What closing costs are associated with a land loan?
Expect to pay loan origination fees, appraisal fees, title insurance, and other standard closing costs much like with a regular mortgage. Closing costs typically run 2-5%.
Can I build my home in phases?
Some lenders offer construction loans that let you draw funds in phases as the building progresses. Otherwise, you may need to take out a second loan once the initial home is completed.
Explore Land Loan Options for Your Dream Property
Purchasing vacant land for your future dream home or development project can become reality with the right land loan. Now that you understand what a lot loan entails, you can determine if this route fits your needs and budget.
I advise
Lot loans come in many forms
Lot loans are mortgages for lots. Not “lots of money,” but financing for a parcel of land on which you want to build a home. There may be a number of paths open to you. And you need to pick the one that’s smoothest for your particular needs.
Raw land vs. lot land
But before we explore those paths, let’s differentiate between “raw land” and “lot land.” People define these in different ways.
- Raw land is just land. which may or may not be suitable for development
- Lot land is intended for residential development, and likely to have at least some of the following:
- A building permit or perhaps appropriate zoning
- A survey report with stakes denoting the site’s boundaries
- Access across public roads OR rights to access through a permanent easement
- Utilities on site or nearby, such as mains water, electricity and perhaps natural gas
- Access to a public sewer or a viable option of providing a private alternative
Borrowing for a lot is typically much easier than getting a loan for raw land. Expect to make a bigger down payment (up to 50 percent) and pay a higher interest rate if you want the latter. Some lenders want to treat these as commercial loans, so be sure to familiarize yourself with how these work if you’re used only to residential mortgages.