Everything You Need to Know About Land Loan Terms and Rates

When it comes to financing a land purchase, land loans offer buyers a way to spread out the cost over time rather than paying the full purchase price upfront. Land loans come with a variety of terms and rates that buyers should understand before committing to a loan. In this comprehensive guide we’ll explain key factors that impact land loan terms and rates so you can make an informed decision when financing your land purchase.

What is a Land Loan?

A land loan, also known as a lot loan, is specifically intended for financing the purchase of vacant land. Land loans function similar to traditional mortgages in that the land serves as collateral on the loan, but they differ in that there is no existing structure on the property being financed.

Land loans allow buyers to acquire property now and pay it off over time. This gives the flexibility to purchase land you may not otherwise be able to afford if required to pay the full price at closing. Land loans can have terms up to 20 years, providing buyers with manageable monthly payments that fit their budget.

Common Uses for Land Loans

There are many reasons a buyer may need to finance a land purchase

• To build a primary residence, Land loans allow buyers to secure their desired property now and obtain financing to construct their dream home later,

• For a future second home or vacation property. Buyers planning for retirement or who want a weekend getaway may purchase a lot now to build on later.

• As an investment. Land can appreciate over time, providing an opportunity for buyers who want exposure to real estate without owning a physical house.

• For agricultural or recreational use. Buyers may want to own farmland, ranching land, or acreage for outdoor recreation like hunting.

What Impacts Land Loan Terms and Rates?

When shopping for a land loan, buyers will find that options vary by lender. However, there are several universal factors that influence the loan terms and interest rates offered, including:

Loan Purpose

Lenders classify land loans based on their intended purpose. Common categories include:

• Raw land loans – For undeveloped land with no improvements.

• Lot loans – For subdivided land plots in a development. May have some basic improvements like utilities access.

• Construction loans – For land that will have a home built on it. More flexibility for funds to be used during home construction.

Loan purpose affects qualification requirements and rates offered. Loans for unimproved raw land tend to have stricter criteria and higher rates given the greater risk to the lender.

Loan Term

Land loans typically have maximum terms up to 20 years. Shorter term loans usually have lower interest rates but higher monthly payments, while longer terms have lower payments with higher overall interest costs.

Common land loan term options:

• 5, 10, or 15 year terms – Lower rates and total interest cost but higher monthly payments.

• 20-year term – Lower payments but pays more total interest over the life of the loan.

• Adjustable terms – Fixed periods (ex. 5/1 ARM) before rate adjusts based on market conditions.

Choosing the right loan term depends on factors like budget, projected length of land ownership, and plans for the property.

Down Payment

The down payment is the portion of the purchase price that comes directly from the buyer. A 20% down payment has traditionally been the norm for mortgages, but land loans often require higher down payments between 25-50% of total cost.

With less collateral securing the loan, higher down payments reduce the lender’s risk on raw land. Buyers who are able to make larger down payments tend to get better rates on their land loans.

Credit Score

As with any financing, a borrower’s credit score impacts loan eligibility and interest rate offered. Those with excellent credit in the 720+ range have access to lower land loan rates that buyers with poor credit cannot obtain.

Many land loans require minimum credit scores in the high 600’s or better. Buyers with weaker credit may need to improve their score or consider alternatives like bringing on a cosigner with better credit.

Loan-to-Value (LTV) Ratio

The loan-to-value ratio compares the amount borrowed against the appraised land value. The combined loan amount and down payment make up the total value.

For example, if a property appraises for $100,000, and a buyer puts $25,000 down while financing $75,000, the LTV ratio would be:

$75,000 (loan amount) / $100,000 (appraised value) = 75% LTV

As a higher LTV ratio equals greater risk, buyers who put down larger down payments tend to get better land loan terms. Typical LTV ratios for land loans fall between 50-80%.

Interest Rate Type

Land loans provide the choice between adjustable or fixed rate financing:

• Adjustable rate mortgages (ARMs) have interest rates that fluctuate over the loan term based on broader economic conditions. ARMs tend to offer lower initial rates with higher long-term risk.

• Fixed rate mortgages keep the interest rate constant over the full loan term once set at closing. Fixed rate loans provide predictable payments but may come with higher rates.

In times of lower interest rates, adjustable rate loans can seem attractive. However, fixed rate loans protect buyers from rate hikes over the life of the loan.

Additional Fees

Lenders may charge origination fees upfront at closing to initiate the loan. An annual servicing fee may also be charged over the course of the loan term. Buyers should account for these costs when evaluating lending options.

Getting the Best Land Loan Terms

As a buyer, there are a few key steps you can take to help secure the best rate and terms on a land loan:

• Get pre-approved – Going through pre-approval allows you to confirm your loan options and improve your bargaining position when negotiating a land purchase.

• Shop multiple lenders – Compare loan estimates across multiple lenders. Local banks, credit unions, and national lenders may offer vastly different loan products.

• Improve your credit – Having credit scores above 700 can mean access to lower rates. Pay down balances and dispute any errors to boost your profile.

• Make a larger down payment – Coming to the table with a more substantial down payment signals lower risk to lenders. Shoot for at least 25% down if possible.

• Ask about discounts – Some lenders offer discounts for autopay, military service, or other factors. Inquire about any available discounts that may reduce your interest rate.

The Bottom Line

When used strategically, land loans allow buyers to purchase property and spread repayment over many years. Pay close attention to factors like loan purpose, down payment amount, credit score, loan term, interest rate type, and lender fees when you evaluate loan offers. And be sure to take the time to shop multiple lenders and compare options to find the best land loan terms and rates for your situation.

Frequently Asked Questions

What is the typical down payment amount for a land loan?

Land loans often require higher down payments than a typical mortgage, usually between 25-50% of the purchase price. Some land loans may allow down payments as low as 15-20% for highly qualified borrowers.

What credit score is needed for a land loan?

Most land loans require minimum credit scores in the high 600’s, with scores of 720+ giving the best terms. Some lenders may approve loans for borrowers with scores in the low 600’s with a sufficient down payment.

Can I get a land loan for raw land with no improvements?

Yes, land loans are available for unimproved land but maximum loan-to-value ratios are lower compared to improved property. Raw land is seen as higher risk by lenders.

Are land loan interest rates higher than traditional mortgages?

Generally yes, land loan rates tend to run 0.5 to 1% higher compared to rates for improved residential property of similar term and conditions.

Should I get a fixed or adjustable rate land loan?

Fixed rate land loans provide predictable payments that won’t increase if rates go up. But adjustable rate mortgages may start with a lower teaser rate. Consider your plans and risk tolerance when choosing.

Conclusion

Financing vacant land has its intricacies compared to buying an existing home with a traditional mortgage. By understanding the various factors that dictate land loan terms and rates, buyers can compare options and select the best loan for purchasing their ideal parcel. Taking the time to shop multiple lenders and improve your financial profile can help land buyers get approved with the most favorable loan terms at the lowest available rates.