The Complete Guide to Land and Building Loans

Buying land and constructing a home from the ground up can be an exciting and rewarding experience. With a land and building loan, you can finance the purchase of the land as well as the costs associated with building a new home. This type of loan simplifies the process by rolling everything into one mortgage.

In this comprehensive guide, we’ll explain everything you need to know about land and building loans, including the pros and cons, interest rates, requirements, and the step-by-step process. Let’s dive in!

What is a Land and Building Loan?

A land and building loan, also known as a construction loan or owner-builder loan, is a mortgage product that allows you to buy land and build a home in one loan. It covers the purchase price of the land as well as the construction costs to build a new house.

With a land and building loan, you only need to apply, close, and make payments on one loan The loan amount will cover buying the land, paying contractors, purchasing materials, and other construction costs.

These loans typically start as a construction loan. Once the home is completed, the loan converts into a traditional long-term mortgage This consolidated process makes building a custom home more feasible

Pros and Cons of Land and Building Loans

Land and building loans offer several advantages but also come with some drawbacks to consider.

Benefits of Land and Building Loans

• One loan for everything – You don’t need separate loans for the land and construction. Everything is rolled into one loan with one application, closing, and monthly payment.

• Potentially easier to qualify – Some land and building loans have lower credit score or down payment requirements compared to other construction loans.

• No down payment – Many land and building loans offer 100% financing so no down payment is required.

• Fixed interest rate – Your interest rate is fixed for the entire term of the loan, starting with the construction phase.

• One closing – You only have to pay closing costs once versus multiple closings on separate loans.

Drawbacks of Land and Building Loans

• Higher interest rates – Interest rates may be 0.5 to 1% higher than rates for traditional mortgages.

• More fees – You’ll pay an upfront fee on the full loan amount instead of just the construction portion.

• Shorter terms available – Most lenders cap land and building loans at 15 or 20 years. Longer 30-year terms are rare.

• More difficult to qualify – Lenders have stricter requirements since it’s riskier than lending for an existing house.

• Limited options – Not all lenders offer construction loans, let alone land and building loan programs.

As you can see, there are advantages and disadvantages to weigh when considering a land and building loan. Make sure to shop around with lenders to find the best loan option for your situation.

Interest Rates on Land and Building Loans

The interest rate on a land and building loan will be higher than rates for purchasing an existing home. You can expect to pay 0.5 to 1% higher with a land and building loan.

Rates are higher because these loans are riskier for lenders than mortgages on completed homes. Construction delays or cost overruns increase the lender’s risk.

Interest rates for land and building loans typically start in the 7-8% range. But a lot depends on your finances and credit score. Work on improving your credit and debt-to-income ratio to qualify for the lowest rate.

Land and building loan rates are fixed. However, payments will be interest-only during construction. The principal and interest payment won’t kick in until construction is finished.

Land and Building Loan Requirements

Land and building loans have stricter eligibility guidelines than conventional mortgages. Here are some common requirements:

• Credit score – Most lenders require a minimum credit score of 620-680. The higher your score, the better chance of approval.

• Down payment – Many land and building loans offer 100% financing but some require 10-20% down.

• Debt-to-income ratio – Your DTI is considered, with many lenders requiring a max of 45%.

• Loan-to-value ratio – Lenders may cap the LTV at 80-90% of the home’s appraised value once construction is complete.

• Construction experience – You may need to demonstrate experience managing home construction projects.

• Contractor requirements – Your builder will need proper licensing, insurance, and strong qualifications.

Always confirm the exact guidelines with lenders as requirements can vary. Stricter criteria help mitigate the risks associated with land and building loans.

How to Get a Land and Building Loan

If you’ve decided a land and building loan is right for you, here are the main steps to obtaining financing:

1. Find the land – Search for and select the property or lot on which you wish to build. Confirm it adheres to zoning and permit requirements.

2. Select house plans – Work with an architect to create house plans and blueprints tailored to your lot.

3. Get pre-approved – Talk to lenders and get pre-approved for financing based on your finances, the land value, and build estimates.

4. Hire a builder – Find an experienced general contractor or home builder familiar with new construction projects. Make sure they meet your lender’s requirements.

5. Finalize land purchase – Work with your real estate agent to finalize the purchase agreement for the land.

6. Close on the construction loan – Finalize the loan, sign documents, and close on the mortgage to finance the land and construction.

7. Start building – Once funds are secured, you can break ground and your contractor can begin construction on your new home.

8. Construction phase – The house is built over a 6-12 month period, with the lender dispensing payments to your contractor in draw phases upon inspection.

9. Construction loan converts – After the home is finished, inspected, and appraised, the construction loan converts to a traditional fixed-rate mortgage.

10. Move in – Once closed as a permanent mortgage, you can move into your brand new custom built home!

It’s a lengthy process but allows you to build your dream home from scratch. Be sure to stay organized and work closely with your lender and contractor throughout.

Alternative Construction Loans

If you can’t find a lender offering land and building loans, here are two alternatives to consider:

Two separate loans – You can opt to get a standard mortgage for the land purchase. Then take out a separate construction loan for building the home. The construction loan can pay off the land loan when finished.

203(k) rehab loan – FHA 203(k) loans allow you to buy a property and finance repairs or renovations up to $35,000. This could be used to construct a modest-sized new home.

Shop around and compare different construction loans and programs. Find the one that best fits your financial situation and home building plans.

FAQs about Land and Building Loans

Here are answers to some frequently asked questions about land and building loans:

Can I build on land I already own?

Yes, you can use a land and building loan to construct on land you already own. The loan can pay off any existing lien on the property.

What credit score is needed?

You’ll likely need a minimum credit score between 620 and 680. The higher your score, the better chance of approval and lower interest rate.

How much down payment is required?

Many land and building loans offer 100% financing but some require 10-20% down. Shop around for a zero down payment program if needed.

Should I get pre-approved?

Yes, you should get pre-approved before making any offers on land. This shows sellers you can secure financing.

How long does the home building process take?

Construction typically takes 6-12 months. Larger or more complex homes may take longer. Discuss timelines with potential contractors.

When do I make my first mortgage payment?

You’ll make interest-only payments during construction. The first full principal and interest payment isn’t due until construction is complete.

Can the loan be used to build a second home?

In most cases, no. Land and building loans are designed for primary residences. Second homes or vacation properties often don’t qualify.

The Bottom Line

Land and building loans allow you to finance the land purchase and construction costs for building a new home. They combine everything into one loan with fixed rates and potential 100% financing.

While these loans make building a custom home more feasible, make sure to consider the pros and cons. Shop multiple lenders to find a loan program that fits your financial situation.

If you want to build your dream home from the ground up, a land and building loan simplifies the process and makes owning the home you’ve always wanted possible.