What You Need To Know About Average Interest Rates For Land Loans

Purchasing land to build a home or start a business on can be an exciting endeavor. However, land is often expensive, so financing is usually required. This means taking out a land loan. Land loans have some key differences from regular mortgages that buyers need to be aware of. One of the most notable differences is that land loans tend to have higher interest rates. So what is the average land loan interest rate and why is it higher? Keep reading to find out.

What Is A Land Loan?

A land loan, also known as a lot loan, is a type of financing used solely for purchasing land – either raw, undeveloped land or improved land that has utilities and infrastructure in place. Land loans are secured loans, meaning the land itself acts as collateral for the loan. If the borrower defaults, the lender can seize the land.

Land loans are different from regular mortgages in a few key ways

• Land loans are considered riskier by lenders since land itself has less inherent value than a developed property with a home on it.

• Land loans typically require a larger down payment, often 20-30% of the purchase price.

• Land loans tend to have shorter repayment terms of 10 years or less.

• Land loans generally have higher interest rates than mortgages.

Why Do Land Loans Have Higher Interest Rates?

On average, land loan interest rates tend to be around 1-2 percentage points higher than mortgage rates. There are a few reasons lenders charge more:

Higher Risk

As mentioned, lenders see land loans as riskier than mortgages since borrowers are more likely to walk away if the land drops in value. Undeveloped land also provides less security for the lender if they have to foreclose. So they charge higher rates to offset this risk.

Shorter Terms

Most land loans max out at 10 years. Longer loan terms spread risk over time, so lenders charge more for short-term land loans.

Fewer Protections

Land loans don’t qualify for the protections and low rates offered by FHA, VA, and USDA mortgages. Conventional mortgages also offer better rate locks.

Less Competition

Far fewer lenders offer land loans compared to the number that offer mortgages. Less competition means lenders don’t have to offer the lowest rates to win business.

No Tax Benefits

With mortgages, interest paid is tax deductible, unlike land loans. So lenders can charge more.

What Is The Average Land Loan Interest Rate?

According to data from Bankrate, the average 30-year fixed land loan rate as of January 2023 was 7.5%. That compares to an average 30-year fixed mortgage rate of 6.33%. So on a $200,000 loan amount and 30-year term, the payment difference would be:

• Land loan at 7.5%: $1,311 monthly
• Mortgage at 6.33%: $1,212 monthly

That’s nearly a $100 per month difference, just from the higher interest rate.

The average 15-year fixed land loan rate is around 6.5%, while 15-year mortgages average 5.55%. And for adjustable rate land loans, the average 5/1 ARM rate is 5.95% compared to 5.3% for mortgage ARMs.

Rates can also vary depending on your credit score, down payment amount, the lender, and general market conditions. Expect to pay toward the higher end if you have bad credit or limited income and assets.

Tips For Getting The Best Land Loan Rate

While land loan rates are inherently higher, it’s still possible to find a competitive rate by following these tips:

• Shop around – Compare quotes from banks, credit unions, farm credit associations, and online lenders. Local lenders may offer better deals.

• Boost your credit – Shoot for a score of at least 720. Pay down debts and dispute any errors on your report.

• Ask about discounts – Some lenders may knock 0.25-0.5% off for autopay or having other accounts with them.

• Make a larger down payment – Loans under 80% of the purchase price often get better rates.

• Shorten the term – You’ll pay less interest with a faster repayment term like 10 or 15 years.

• Consider an ARM – The initial rate on an adjustable-rate mortgage is lower than on fixed-rate loans.

• Use owner financing – If the seller provides the loan, they may offer better terms than banks.

• Time it right – Try to get a rate lock when land loan rates dip. Check rates daily.

With some preparation and research, you can potentially find a land loan rate that’s a bit more competitive with current mortgage rates. That can save you thousands over the life of the loan.

When Are Land Loans A Good Idea?

Given the higher rates and tougher terms, you may be wondering if a land loan is ever a smart move compared to a regular mortgage. Here are some situations where a land loan does make good financial sense:

• You want to purchase land as an investment and hold it for appreciation rather than build right away

• You have an ideal parcel picked out but need time to save up for construction

• You plan to use owner financing from the seller for better terms

• You intend to pay off the land quickly within 5-7 years

• You can get a construction loan after buying the land

• Interest rates are low enough to justify financing the land

• You can afford the higher monthly payments

If you take the higher rates and fees into account and are comfortable with those costs, financing land can work out well. However, paying cash for land is always the cheapest option if possible.

Alternatives To High-Interest Land Loans

Besides paying cash, there are also some alternatives to taking out a traditional land loan that can potentially save you money:

• Home equity loan – If you have sufficient home equity, you may be able to qualify for a better rate compared to land loan rates.

• 401(k) loan – If allowed, borrowing against your 401(k) could provide access to lower rates, though under strict repayment terms.

• Owner financing – As mentioned, having the seller provide financing can open the door for better terms.

• Crowdfunding – Using peer-to-peer lending sites to crowdfund the purchase money could be an option. The rates and terms vary.

• Hard money loans – A short-term loan from a private investor that is secured by the land can help you buy and flip quickly.

• Partnership – Joining forces with family or a business partner to buy the land can provide easier access to financing.

The Bottom Line

Land loans tend to be 1-2% higher than average mortgage rates since they are considered to be riskier and lack the protections of mortgages. But it’s possible to find competitive land loan rates, especially through owner financing, 401(k) borrowing, or home equity. You should weigh the loan amounts and costs against your budget and plans for the property. In certain situations, even relatively high interest land loan rates can be justified and affordable. But cash or alternative financing is ideal if possible.