Have you ever wondered how does a construction loan work when you own the land? Building a commercial property requires a significant amount of funds, especially when you own the land. In such cases, construction loans can come in handy, providing the necessary financial support to complete your project.
A construction loan is a unique type of loan that is designed to help construct a new building or renovate an existing one. But how does a construction loan work when you already own the land? This guide will provide you with everything you need to know about construction loans when you own the land.
If you plan to build your dream home from the ground up, one of the first steps is securing financing. Construction loans provide the funds to both purchase land and construct a custom home in one single loan
But a common question homebuilders have is whether the loan covers just the build, or if it also includes purchasing the lot or land I’ll provide a detailed overview explaining if and when construction loans include financing for the land purchase
Here’s what I’ll cover:
- How Construction Loans Work
- Do Construction Loans Include Land Purchase?
- Construction-Only Loans
- Construction-to-Permanent Loans
- Tips for Financing Land and Build
- Finding the Best Loan for You
Let’s dive in!
How Do Construction Loans Work?
Before looking at whether these loans cover land, it helps to understand what construction loans are and how they work.
A construction loan is a short-term financing option specifically for building a new home. The loan provides funds incrementally to your builder during each phase of construction.
Here are some key points about construction loans:
- The lender pays the builder directly, not the borrower
- Funds are dispersed in installments (draws) after inspection
- Interest-only payments are made during construction
- The loan can convert to a permanent mortgage after completion
Construction loans give homebuilders access to financing in stages aligned with the building timeline. This saves you from having to obtain and repay a traditional lump sum loan.
Do Construction Loans Include the Land Purchase?
Whether the loan covers the cost of the land depends on the type of construction loan you choose. There are two main options:
Construction-Only
- Covers just the build costs
- Land purchase separate
- Higher interest rate
Construction-to-Permanent
- Combines land and build
- Single closing
- Lower interest rate
As you can see, construction-to-permanent loans bundle the financing for purchasing land and constructing the home. But construction-only loans keep these two transactions separate.
Let’s take a closer look at how land is handled with each loan type.
Construction-Only Loans Don’t Include Land
With a construction-only loan, the financing covers only the direct costs of the home building project. This includes things like:
- Builder fees
- Materials
- Labor
- Permits
- Contingency reserve
The loan provides funds incrementally as each stage of construction is completed. But the land purchase is a separate transaction you need to finance independently.
Some ways to cover the land purchase include:
- Cash (savings, gift, inheritance, etc.)
- Separate mortgage or land loan
- Seller financing
Since the land and build costs are separated, you’ll also have two closings – one for the lot purchase and another for the construction loan.
Construction-only loans offer flexibility but less convenience since the land and build aren’t combined.
Construction-to-Permanent Loans Include Land
Construction-to-permanent loans bundle the financing for both the land acquisition and home construction into a single loan.
With this loan option, the funds can be used to:
- Purchase the lot
- Pay builder fees
- Cover materials
- Finance other construction costs
There’s a single closing where you finalize the land sale and construction loan simultaneously. The interest rate is also typically lower than a construction-only loan.
Once building completes, the loan converts to a permanent mortgage so you don’t have to requalify or redo financing.
For homebuilders who want maximum simplicity and convenience, a construction-to-permanent loan is usually the best fit.
Tips for Financing Land and Construction
If you want your construction loan to cover purchasing land, here are some top tips:
Find the Right Lender – Not all lenders offer construction loans that include land. Reach out to lenders experienced with this loan type.
Have Funds for Down Payment – You’ll likely need at least 20% down for the combined land and construction costs. Factor this into your budget.
Know Timeline for Lot Purchase – To bundle the transactions, the land purchase must align with construction timeline.
Close Simultaneously – You’ll finalize both the land sale and loan at a single closing for maximum convenience.
Lock In Low Rate – Construction-to-permanent loans offer better rates, but still shop around for the best deal.
With the right lender and proper planning, you can smoothly finance the land and construction together.
Which Loan is the Best Fit?
There are pros and cons to both construction-only and construction-to-permanent loans when it comes to financing land. Consider which fits your unique situation best.
Construction-Only
- Flexibility in separate land purchase
- Potentially lower long-term rate
Construction-to-Permanent
- Simplicity of one closing
- Single loan for land and build
- Lower short-term rate
Look at both loan types and weigh the factors like convenience, rates, timeline, and budget. This will help determine if it’s best to combine land and build financing or keep them separate.
Let’s Sum It All Up
Figuring out if a construction loan covers purchasing land is an important first step when planning your custom home build.
Key points to remember:
- Construction-to-permanent loans bundle land and build
- Construction-only finances just the home construction
- Shop around to find the best loan and rate
- Timeline must align for combined land and construction financing
Getting Approved for a Construction Loan
To get approved for a construction loan, you’ll need to supply proof of income, tax returns, and credit score information. Plus you need to have a low debt to income ratio. The lender will also assess the quality and value of the land and the property that will be built on it. A good credit score and a solid financial history could increase your chances of getting approved. Make sure you have a down payment and closing costs prior to applying with construction loan lenders.
Construction loans work differently than traditional mortgage loans. Disbursement of the loan amount is not made in one lump sum payment. Instead, the loan is paid out in stages known as draw schedules. The lender will inspect the site before releasing payments to ensure that the construction project is progressing as planned and is in line with the loan agreement.
When you own the land
One of the most significant advantages of a construction loan is that it can be used to cover the cost of land acquisition. If you have already purchased the land where you plan to build your commercial property, a construction loan could be the ideal solution to finance construction costs. This type of loan can also cover the cost of site preparation, labor, and material expenses that come with the construction process.
Can I use my land as down payment for a construction loan?
FAQ
Should I pay off my land before you build?
Is a construction loan harder to get than a mortgage?
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