Can You Use Land as a Down Payment for a Construction Loan?

The short answer to the question “Can I use my land as equity for a construction loan” is yes.

If you own your land outright (no mortgage or liens) you can likely use your equity in the land toward the purchase of a new home. In this scenario, you could use your equity in the land as collateral or obtain a new loan against property and use the funds as a down payment on building your new home.

There are other factors, of course. The value of your land, the sales price of the home you wish to build, your credit score/credit history, and loan programs you can qualify for will all be determining factors in the use of land as equity for a loan.

If you’re looking to build your dream home, you may be wondering if you can use land you already own as the down payment for a construction loan. The short answer is – yes you typically can use land equity as your down payment when taking out a construction loan.

What is a Construction Loan?

A construction loan is a short-term loan used to finance the building of a new home. It covers the costs of construction, including materials and labor, until the home is completed. At that point, the construction loan converts into a traditional mortgage.

Construction loans allow you to only pay interest on the amount dispersed during the building phase You don’t start making principal payments until the home is completed and you convert to a regular mortgage.

Benefits of Using Land as a Down Payment

Using land you already own as a down payment for a construction loan has several advantages

Leverage existing equity: The equity you have built up in your land can be used as your down payment on a construction loan. This allows you to maximize the amount you are financing.
Potentially avoid PMI: With a larger down payment from your land equity, you may be able to avoid paying private mortgage insurance (PMI).
Lower monthly payments: A larger down payment results in lower loan principal and potentially lower monthly mortgage payments.
Increase loan eligibility: Lenders may look more favorably on your loan application if you put down 20% or more from land equity.

How Land Equity Works as a Down Payment

Lenders will look at the total appraised value of the land and the home you intend to build when considering your construction loan application. Here is an example:

You own land valued at $100,000 that you have paid off completely.
You get an estimate that building the home will cost $300,000.
The total appraised value of the land and planned home is $400,000.
Your land equity of $100,000 represents a 25% down payment on the total $400,000 value.

In this scenario, your existing land equity covers the down payment requirement for the construction loan. The loan would be for $300,000 – the cost to build the new home.

What Lenders Look For

When using land as a down payment, lenders will evaluate:

Appraised land value: Documentation such as an appraisal from a licensed appraiser showing the current fair market value of the land.
Land ownership: Proof you own the land free and clear through a copy of the deed or title. There can be no liens or loans secured by the land.
Land eligibility: The land meets requirements such as proper zoning for residential building.
Total project costs: Detailed construction budget showing all costs (materials, labor, fees) to build the planned home.
Plans and specs: Building plans, blueprints, specs documenting what home you intend to build.
Builder qualifications: Your builder’s credentials, reputation, and proof of insurance. Many lenders have approved builder lists.

The Construction Loan Process

If using land as a down payment, the general construction loan process involves:

Getting pre-approved to use your land equity as down payment
Having your land formally appraised to determine value
Finding a qualified builder if you don’t already have a relationship
Finalizing detailed building plans and specs
Applying for the construction loan and providing required documents
Closing on the loan and starting the build
Making interest-only payments during construction
Converting to a mortgage upon project completion

Tips for Success

Follow these tips to successfully use your land equity as a construction loan down payment:

Shop around with multiple lenders to find the best loan terms and rates.
Be conservative with your build budget and timeline to avoid cost overruns.
Understand the loan draw process and have a funding schedule in place.
Get everything in order early – plans, permits, insurance, contractor.
Keep a detailed paper trail of all expenses, invoices, payments, changes, etc.
Be prepared to make interest-only payments during the build phase.
Oversee the project closely or hire a construction manager.
Convert to your permanent mortgage immediately upon completion.

Using your land equity as a down payment for a construction loan to build your dream home can be a great option. Make sure you understand the process, requirements, and your responsibilities before embarking on the journey.

Shop Lenders and Find the Right One For Your Project

Be sure to find a lender that has experience with residential construction financing. Shop rates and get the best terms you can. You will need an accurate budget to work with lenders. Your contractor and a good residential construction lender can help you come up with an accurate budget for the home that you want to build.

How Much Can I Borrow for a Construction Loan?

The answer varies based on several factors. You may be able to borrow up to :

75% of the project appraised value– Most lenders will loan up to 75% of the appraised value of the home you are building.
95% of the construction costs – if you are in a strong financial position (perfect credit history, regular income, genuine savings)
80% of the value of the land plus construction costs – if you can find the right lender (most banks won’t lend for cost plus building contracts).
Borrow up to 100% with a guarantor loan – a guarantor loan is usually a parental guarantee (a family member using real estate that they own as additional security for your loan).

Can I use my land as down payment for a construction loan?

FAQ

How is land used as a down payment?

When you use land equity “in lieu” (instead) of cash to make the down payment on a loan, it’s called “land in lieu” financing. This type of arrangement is typically associated with borrowers who want to finance a manufactured home or the construction of a home on land they already own.

Can you use land as collateral for a mortgage?

Many lenders will allow land — either owned or received as a gift — to be used as collateral instead of a cash down payment when obtaining financing to purchase a new home.

Is it better to buy land first and then build?

Pro: Having a lot acquired can help you secure a more encompassing bank loan for construction. Some banks will cover the entirety of your building expenses with a construction loan. Con: Buying land first then building means more upfront equity.

Can you use land as a down payment for a FHA loan?

The Land. If you already own a plot of land on which you intend to build a home, you are a step ahead in the process. Your land equity will cover the down payment requirement (3.5% minimum for FHA loans). You might need to purchase the lot; in which case it is important to think long term.

Can a construction loan be used as a down payment?

“So, in this scenario the $50,000 piece of land that you own is the down payment on the $350,000 final value of the home. That’s a little more than 14% down!” Put simply, if you already own land, the equity that you have in that land can be used as your down payment for your construction loan.

Can I use land as a down payment?

Whether or not it is possible, or a sound financial decision, for you to use your land or land equity to establish a line of credit or take out an installment loan for the construction down payment depends on a few factors. HOW DOES USING LAND AS A DOWN PAYMENT WORK?

Can a land equity loan be used for construction?

If you are approved for a land equity loan or line of credit, you can use these funds for whatever you like, including a down payment for the construction of your home. What is a land equity loan? A land equity loan will allow you a lump sum to spend on your construction down payment with the option of a fixed or variable interest rate.

Can you get a construction loan if you own land?

If you own your land and would like to build a home on it, you may be able to use the land’s equity to get a construction loan. Residential construction loans that transition to mortgage loans are a popular way to do this. You’ll still need to qualify for the loan the same way you would a mortgage.

Can you pay land equity loan and construction costs at the same time?

Construction can sometimes be stalled or over budget, so make sure you can afford to make payments on your land equity loan and construction costs simultaneously. Understand that if you abandon the building process for whatever reason, or want to sell the home, you’ll still be paying the land equity loan.

How much down payment is needed to build a house?

“Let’s say you have a $50,000 piece of land that’s paid for and you’re going to build a $300,000 house. The total value (home plus land) is $350,000,” she explained. “So, in this scenario the $50,000 piece of land that you own is the down payment on the $350,000 final value of the home. That’s a little more than 14% down!”