Land Loans vs Home Loans: What’s the Difference?

When it comes to financing real estate you have two main options – land loans and home loans. But what exactly is the difference between these two types of loans? I’ll break it down in this article so you can decide which route is best for your situation.

An Overview of Land Loans

A land loan, also known as a lot loan, is specifically used to purchase a vacant plot of land. This type of financing allows you to buy land with the intent to build a home or use the property for commercial purposes down the road.

Land loans are obtained similarly to a traditional mortgage – you’ll apply, get approved, and make payments over time However, securing financing can be more difficult since there is no actual property being used as collateral Because of this, land loans typically have higher interest rates and require larger down payments than home loans.

There are a few different types of land loans:

• Raw land loans – For completely undeveloped land with no utilities or infrastructure. Most risky type of land loan.
• Unimproved land loans – Land has some basic utilities but lacks things like electric/gas meter. Less risky than raw land.
• Improved land loans – Land has roads, electricity, water access. Easiest type of land to get financing for.

No matter what type of land you want to buy, interest rates will be higher and you’ll likely need at least 20% down payment or more. But improved land has lowest rates/down payment requirements.

Home Loans Overview

Home loans, also known as mortgages, let you finance the purchase of an existing residential property or refinance a home you already own. The home itself acts as collateral for the loan, making this type of financing much less risky for lenders.

As a result, home loans have lower interest rates – typically starting around 2-3% for a 30 year fixed rate conventional mortgage. Down payment requirements are also lower, with options like FHA loans allowing as little as 3.5% down.

Beyond purchase mortgages, you can also take out home equity loans or lines of credit using your home as collateral. This lets homeowners tap into their equity for other financial needs.

Comparing Land Loans vs Home Loans

Now that you understand the basics, let’s directly compare some of the key differences between land loans and home loans:

• Interest rates – As mentioned above, land loan rates are higher, potentially 1-1.5% higher for the same borrower.

• Down payments – Land loans require larger down payments, often 20% or more. Home loans can be 3.5% down or even 0% down in some cases.

• Loan term – Land loans tend to have shorter terms of 5-10 years. Home loans are most commonly 15 or 30 year terms.

• Collateral – Land cannot be used as collateral like a home, making land loans riskier.

• Use of funds – Land loans are for purchasing vacant property only. Home loans allow purchase of existing property or refinancing.

• Ease of approval – Home loans are easier to qualify for given lower risk. Land loans have higher standards.

As you can see, the lack of collateral and increased risk with land loans leads to worse financing terms compared to a home loan. But land loans give flexibility to purchase and hold land for future development.

When to Use Land Loans vs Home Loans

Given the key differences, when should you consider a land loan vs home loan?

Land loans make the most sense when:

• You want to purchase vacant land to build on in the future.

• You need raw land for commercial use like farming or business development.

• You want to buy land as an investment property for future appreciation.

• You need time to develop land and aren’t ready to build immediately.

Home loans are better when:

• You want to buy a house that’s already been built.

• You need to refinance an existing home you own.

• You need equity from an existing home via cash-out refinance or home equity loan.

• You want better terms like lower rates/down payment and longer repayment.

Really it comes down to whether or not you plan to purchase and develop vacant land or buy a property that is already built. Both financing options have their place in real estate transactions.

Getting Land Loan Financing

If you’ve weighed the pros and cons and decided a land loan is right for your situation, here are some tips for getting approved:

• Seek out local community banks and credit unions near the land you want to buy. Smaller institutions are more likely to finance vacant land.

• Come prepared with a detailed plan for developing the land to show lenders. This helps reduce perceived risk.

• Have excellent credit – 720 score or higher gives you the best shot.

• Make a large down payment if possible, at least 20% or more.

• Be ready to accept higher interest rates and shorter repayment terms.

• Ask about USDA land loans for rural properties or SBA loans for commercial land. These government-backed loans can offer more favorable terms.

The better your finances and more solid your plans are, the easier it will be to get a lender comfortable with issuing you a land loan.

Alternatives to Land Loans

If you are having trouble getting approved for a land loan, here are some alternatives worth considering:

• Home equity loan – Tap equity from an existing home you own to buy land outright. Avoid land loan requirements.

• Seller financing – Seller carries the loan instead of a bank. May offer more flexible terms.

• Crowdfunding – Use real estate crowdfunding to pool money from multiple investors.

• Partnerships – Team up with others to buy larger parcels of land.

• All cash purchase – Scrap the loan and buy with cash if possible.

• Lease-to-own – Rent the land first, then purchase once you have more resources.

Depending on your financials and credit, these options may allow you to purchase land without dealing with the stricter requirements of a conventional land loan.

Weighing Your Options

Only you can decide if applying for a land loan or home loan works best for your real estate goals. Land loans give you flexibility to purchase vacant land, while home loans provide better terms for buying an existing property. Carefully assess your finances, plans for the property, and urgency to determine which route to take.

And don’t forget to shop around with multiple lenders to compare loan options. Be sure to pay close attention to interest rates, down payments, terms, and approval criteria when making your decision.