Moving away from the city life’s hustle and bustle to build a custom home on acreage is a dream many share. Buy land, build a house, live happily ever after. While the concept is simple, the process can be daunting. We’d like to give you an overview of what it takes to make this dream come true.
First, you’ll need to purchase the land for your future homesite. Texas Farm Credit’s mortgage division can finance anywhere from 5 to 100 acres with the loan process basically remaining the same. Meaning you’ll need a minimum of 15 to 20 percent as a down payment, as well as cash to cover the closing costs.
Traditionally the next step after the land purchase is designing your home, selecting your builder, and obtaining a final construction bid. We encourage customers to spend time shopping builders to find the one that’s right for you. You’ll be working closely as they build your home, so you want to feel comfortable with their communication style, work ethic, and trustworthiness.
Once you find the right builder, it’s time to start building. To do that you, need to apply for an interim construction loan. Construction loans are typically set up to cover the project’s entire cost, including the land and home construction. To close on this loan, you’re responsible for another down payment and set of closing costs. Depending on the equity in your property, you may be able to roll the down payment and the closings cost in with your construction loan.
You should know that an interim construction loan is very unique – unlike traditional mortgage loans where the entire loan amount is advanced upfront to pay the sellers. Construction loans payout in draws. For instance, the first draw on your loan may be to pay off the existing land loan. Another example would be after pouring the foundation and completing framing, your builder would apply for a draw of funds to cover that cost.
The builder is responsible for draw requests and detailing expenses. You will review and approve the requests, and then Texas Farm Credit will advance funds directly to the builder. This will go on until construction is complete, and the total amount of your loan has been drawn.
Most mortgage companies will offer you a two-time close loan, but because Texas Farm Credit specializes in rural lending, we offer a one-time close option.
Two-time, one-time, what does all this mean? Don’t worry, I won’t leaving you hanging. On a two-time close loan, you’ll first apply for an interim construction loan, which may include a down payment and closing costs. Once construction is complete, you’ll apply for your final mortgage, which refinances your land and new home into one conventional mortgage loan. In that loan scenario, you may have some equity built up, which could benefit your loan terms, but closing costs are unavoidable.
But when you get the one-time close construction loan, you won’t have to apply for financing, pay closing costs, or go through the closing process again after the home construction is complete. You simply apply for one loan that covers the construction and final mortgage in a straightforward package.
To be considered for a one-time close, you will need your home plans and construction bid ready to go at the time of land purchase.
A one-time close comes with a host of benefits: you begin building equity in your property sooner, you can lock-in your interest rate at the beginning of the whole process, you’ll save the closing costs from the after-construction loan closing, and best of all – you won’t have to worry about figuring out financing again. You can just move in and enjoy your new home!
Buying a piece of land and building a home on it takes healthy cash reserves, determination, and a lender like Texas Farm Credit who can walk you through each step in the process and save you time and money with a one-time close.
We’ve outlined a standard case here, but each home is different, and we treat each mortgage customer with care and fresh eyes because each project is always unique. We’ll explain every detail, stay in communication all along the way, and make sure you get the best loan package to suit your needs.
Yes. There are multiple options that a lender may allow. One is to join the land loan with the new construction loan into one. However, paying off your land before building your house may help you earn more favorable loan terms for your construction loan.
You’ll need a construction loan to finance the actual build. Construction loans can be either one-time close or two-time close loans. You can learn more about how Texas Farm Credit finances these loans here.
Standard down payments vary. A typical down payment for Texas Farm Credit members is 20% of the total purchase price. Paying more than that will allow you to take out a smaller loan and pay less interest long-term.
Some buyers choose a lot location first, then build their house later. This allows them to secure a location they love early in the process, then spend some time saving money for construction and building equity in the purchased land.
Long-term, it could be more expensive to build a house from scratch on raw land rather than buying an existing house. If the land is undeveloped, you may have to pay for septic tank installation, a water well, electric line hookups, or new permit fees, for example. However, the benefit is that you get to choose exactly how your new home is built. For a full cost breakdown of building vs buying a house, learn more here.
The cost to buy land and build a house depends on your location and the specifics of the home to be built. Land prices vary quite dramatically across the country, while construction costs are slightly more consistent. Assuming average prices for components and services like architectural plans, site preparation, foundation, framing, plumbing and electric, interior finishing, and all associated permits, a 2,500-square-foot home would likely cost $300,000-$500,000.
We are not lawyers, accountants, or financial advisors and the information in this article is for informational purposes only. This article is based on our own research and experience and we do our best to keep it accurate and up to date, but it may contain errors. Please be sure to consult a legal or financial professional before making any decisions.
Purchasing land and constructing a custom home from the ground up can be an exciting and rewarding experience. Having full control over the design layout, features, and location of your dream house is allureing to many prospective homeowners. However this process also involves considerably more effort, coordination, and financial commitment than buying an existing house. Securing the proper financing is one of the most critical steps for successfully buying land and building a house. This comprehensive guide examines popular loan options, eligibility requirements, pros and cons, and tips for obtaining the ideal loan for your new construction project.
Overview of Loan Types for Land and Construction
When embarking on a new home build, you’ll need separate financing for purchasing the land and then constructing the house. Some of the most common loans include:
- Land Loan – A loan specifically to buy vacant land. Usually requires 20-50% down payment.
- Construction Loan – Interim financing to pay for building costs. Converted to permanent mortgage after completion.
- USDA Loan – Government-backed loan for rural properties. 100% financing, no down payment.
- 203(k) Rehab Loan – FHA insured loan covers land purchase and construction. 3.5% down payment.
- One-Time Close Construction Loan – Single loan for land and construction costs. Avoid costs/hassle of 2 loans.
The best loan type depends on your financial situation, the property location, and specific lender requirements. Doing thorough research upfront is essential to select the optimal financing strategy.
Land Loan Requirements and Process
Land loans help buyers purchase vacant property to hold for investment or future development Typical requirements include
- Down payment of 20-50%
- Credit score over 620
- Debt-to-income ratio below 43%
The land loan process involves
- Getting pre-approved
- Identifying and selecting land
- Submitting purchase offer
- Completing loan application and documentation
- Receiving approval and closing on loan
- Making monthly payments on the loan
Land loans are usually for shorter terms up to 20 years with variable interest rates. Closing costs are similar to other mortgages around 2-5% of the loan amount.
Construction Loan Eligibility and Application
Construction loans provide short-term financing to build a new house on owned or newly acquired land. Typical requirements are:
- Minimum 680 credit score
- Down payment of 20% or more
- Lower debt-to-income ratio (often below 40%)
The construction loan process involves:
- Finding land and drafting house plans
- Getting pre-approved from a lender
- Submitting full application with land/house details
- Having land and plans appraised
- Receiving loan approval and securing builder
- Making interest-only payments during construction
- Completing build and converting to permanent mortgage
Construction loans have variable rates, lower loan-to-value ratios, and stricter credit requirements than traditional mortgages. Closing costs are higher as well.
USDA Loan Benefits and Drawbacks
USDA loans are an attractive option because they require no down payment and offer 100% financing. Key benefits include:
- No down payment required
- Lenient credit score requirements (>640)
- Below market interest rates
- Low monthly mortgage insurance
The cons of USDA loans include:
- Limited availability and difficult to find lenders
- Home and land must be in eligible rural area
- Applicant income must be below limit for area
- Must use USDA approved builder
- Lengthy application and approval process
USDA loans can finance the land purchase, construction, and provide permanent financing all in one loan. This avoids the hassle and fees of refinancing.
FHA 203(k) Rehab Loan Features
FHA 203(k) loans allow buyers to purchase a property and finance repairs or renovations up to $35,000. This FHA-insured mortgage can also be used to buy land and build a new house. Key features include:
- Down payment as low as 3.5%
- Available with credit scores as low as 580
- Finance land purchase and construction costs
- Only one set of closing costs
Drawbacks of 203(k) loans are that they require using a 203(k) consultant and have a lengthy approval process. Borrowers should also be prepared for higher interest rates and closing costs.
One-Time Close Construction Overview
Also called a single-close or all-in-one loan, this combines land purchase, construction financing, and the permanent mortgage into one loan. Benefits include:
- Purchase land and build home with one loan
- Only one set of closing costs
- Avoid fees and hassle of refinancing later
- Often more easily available than standalone construction loans
Drawbacks are that it requires starting the building process very soon after purchase and rates may change from construction to permanent financing stage.
Tips for Finding the Best Loan for Your Situation
- Check if land is in USDA eligible area to see if you qualify
- Shop multiple lenders to compare loan options and rates
- See if you can use current land you own to save on purchase costs
- Look at alternatives like owner-building if you can’t get approved for traditional financing
- Get cost estimates from builders to determine loan amount needed
- Ask lenders about one-time close construction loans to streamline process
- See if you qualify for special programs for first-time home buyers or low-income borrowers
Doing thorough research and planning ahead is key to successfully financing your dream home construction project. Examining all your loan options will help you find the optimal type of financing for purchasing land and building your custom home.
Frequently Asked Questions
What credit score is needed for a construction loan?
Most lenders want to see a minimum credit score of 680 for approval on a construction loan given the additional risks and complexities involved. Some may approve scores as low as 640 with strong assets or income.
Should I pay off my land loan before getting a construction loan?
It is generally recommended to pay off the land loan first and have clear title to the property before taking out a separate construction loan. Some banks may allow combining them, but it can complicate approval.
What are closing costs on a land and construction loan?
Closing costs will vary by lender and loan type, but expect to pay around 2-5% of the total loan amount. This covers origination fees, appraisal, credit check, title fees, and other costs. Shopping lenders can help minimize closing costs.
Can I get an owner-builder construction loan?
Yes, some banks do offer construction loans for owner-builders. These usually have stricter requirements on construction experience and may mandate hands-on project management. Interest rates may also be higher.
What is needed to qualify for a USDA construction loan?
To qualify for a USDA construction loan you’ll need a minimum 640 credit score, debt-to-income ratio below 41%, income below limit for area median, land and house plans approved by USDA, and use of an authorized USDA builder.
The Final Word
Building your dream home on purchased land can enable you to fully customize your ideal living space. But buying land and constructing a house also requires significantly more upfront planning and financing coordination. Be prepared for a lengthy process spanning 6 months to 1 year. Do your homework to find lenders offering the type of land and construction loans or financing programs best matched to your financial situation and prospective property. Aligning the right financing early on will help ensure your new home build goes smoothly from raw land to turnkey home.
About the AuthorJenny Zagst
Jenny Zagst joined the team in August 2012 as a charter member of the Texas Farm Credit Mortgage Division. With an extensive traditional real estate background, she can appreciate Texas Farm Credit’s unique ability to finance homes on acreage. Jenny enjoys horseback riding, hunting, fishing and being outdoors. As Tyler, Texas natives, she and her husband enjoy raising their son and daughter in the heart of East Texas.