Everything You Need To Know About Getting A Loan For Buying Land And Building A House

Purchasing land and building a custom home from the ground up is an exciting prospect for many prospective homeowners. With a custom build, you can create the house of your dreams with all the amenities, layout, and design elements you want

However financing the purchase of the land and construction of a new house requires specialized loan products that are different from a typical mortgage used to buy an existing house. In this comprehensive guide I’ll walk you through the various loan options available for buying land and building a home so you can determine the best route for your needs and budget.

Overview of Loan Options For Land and Construction

When looking to buy land and build a new home, you have three main loan options:

• Land Loan – This type of financing is used solely to purchase the plot of land you intend to build on.

• Construction Loan – This short-term loan covers the costs to build the home such as materials, labor, permits, etc.

• Combined Land and Construction Loan – One loan that covers both the land purchase and home construction.

While you can take out separate loans for the land and construction, a combined land and construction loan (also called a one-time close construction loan) offers the simplicity of having just one loan and closing process.

Below I’ll explore the key details of each type of loan so you can decide if you want separate or combined financing.

Land Loans

Before you can break ground on your new home, you first need to purchase the lot or land you’ll build on. Land loans are specifically designed for financing the purchase of vacant land.

With a land loan, you can buy the property and then repay the loan over time, similar to a mortgage. Here are some key factors to understand about land loans:

• Down Payment – Most lenders require at least a 20% down payment on a land loan. This helps mitigate their risk since there won’t be a completed home as collateral.

• Interest Rates – Land loan rates are typically higher than mortgage rates, often by 1% or more. You’ll also have fewer term options, usually between 5-15 years.

• Loan Amounts – Most land loans fall between $10,000 – $500,000. The value is based on the appraised value of the vacant land.

• Credit Score Requirements – Expect land loan programs to require a minimum credit score around 640. Some may require higher.

• Repayment – The loan term will dictate your repayment schedule, such as monthly installments over 5-15 years.

While they come with stricter criteria, a land loan allows you to finance an empty plot of land with no immediate plans to build. Just make sure the property is zoned properly for your future construction plans.

Construction Loans

Once you have the land purchased, it’s time to finance the building of your new home. This is where construction loans come into play.

Construction loans provide short-term financing to cover all costs related to building the home, including:

• Materials
• Labor
• Permitting fees
• Builder fees
• Other construction costs

Here are some important features of construction loans to understand:

• Down Payment – Expect to make a 10-25% down payment on the total projected cost to build the home.

• Loan Amounts – The loan amount will be based on the appraised value of the completed home. Loan amounts often range from $100k up to several million dollars.

• Interest Rates – Construction loans have variable rates that are tied to an index like the Prime Rate. The rate will fluctuate over the loan term.

• Loan Term – Terms are typically under 2 years to cover the construction period. Once the home is completed, you’ll convert it to a traditional mortgage.

• Repayment – During construction, you’ll make interest-only payments. Once converted to a mortgage, principal and interest payments begin.

• Credit Score Requirements – Construction loans often require a minimum score around 680.

Construction loans provide vital short-term financing so you can build your dream home. Just know that you’ll need to transition to permanent financing once construction is wrapped up.

Combined Land and Construction Loans

Rather than take out separate loans for the land purchase and home construction, some lenders offer combined land and construction loans.

Also called one-time close or all-in-one construction loans, these provide simplified financing to:

• Purchase the land
• Finance construction costs
• Serve as the permanent mortgage once the home is built

Benefits of combined land and construction loans include:

• One closing process
• A single application and approval
• No need to requalify for permanent financing
• Potentially lower interest rates
• Only one set of closing costs

However, these loans can be challenging to find and have strict eligibility guidelines. You’ll likely need pristine credit and meet debt-to-income requirements. The property must also be located in an eligible rural area for some programs.

While combined loans simplify the process, they may not be right for everyone. Carefully compare options to decide what works for your situation.

USDA Loans

If your land is in an eligible rural location, you may qualify for a loan through the U.S. Department of Agriculture (USDA). The USDA offers loans that combine land financing, construction costs, and a permanent mortgage all in one.

USDA construction loans offer several perks:

• 100% financing – No down payment required
• Below market interest rates
• Low monthly mortgage insurance

However, as a government program, USDA loans come with limitations. You must meet income and credit requirements and build within a qualified rural area. The home must be your primary residence and you must use an approved contractor.

Still, a USDA loan can be an affordable financing option if you meet the requirements. Be sure to explore eligibility and availability in your local area.

VA Loans

Veterans and active military may utilize VA loans to buy land and build a home. You can use a VA construction loan to finance the building costs separately from the land purchase. Or look for VA one-time close construction loans that combine land and building costs.

VA loans offer favorable terms like:

• 100% financing with no down payment
• Competitive interest rates
• No monthly mortgage insurance

However, VA construction loans require you to use a VA approved lender and builder. Homes must meet VA property requirements as well. While restrictive, VA loans let eligible borrowers build a home affordably.

How To Find The Best Loan For Your Needs

With multiple loan options available for buying land and constructing a home, it’s essential to shop around and compare programs thoroughly. Here are some tips for finding the best loan for your situation:

• Check eligibility for government-backed loans like USDA, VA, and FHA programs first since they offer the most favorable terms if you qualify.

• Research local community banks, credit unions, and mortgage lenders to ask what construction loan products they offer. Many national lenders don’t offer these types of loans.

• Ask potential lenders if they provide combined land and construction loans or if separate loans are required. This will impact your loan process.

• Inquire about interest rates, loan terms, credit score requirements, and down payment demands to find the most affordable option.

• Get pre-qualified so you know the loan amount you can receive and can comparison shop effectively.

Take the time to explore multiple lenders and loan products. This will help you identify the optimal financing solution for purchasing land and building your dream home.

What To Look For In A Lender

Not all mortgage lenders offer construction loans, so finding one with experience is key. Here are some top factors to look for when selecting a lender:

• Experience – Find a lender with extensive knowledge in construction lending. They should be able to easily explain the process and requirements.

• Range of products – Choose a lender that offers both construction loans and permanent mortgage options for when your build is complete.

• Industry knowledge – Select a lender familiar with zoning laws, permitting, and regulations that impact the building process in your area.

• Builder relationships – Some lenders have existing relationships with reputable local builders, which can be beneficial.

• Stability – Opt for an established lender that has been in business for many years and through multiple economic cycles.

• Responsiveness – Look for a lender that is easy to reach and provides timely responses to your inquiries and application.

Taking the time to vet potential lenders will help you select one that can smoothly guide you through the construction loan process.

What Factors Impact Loan Eligibility and Terms?

When applying for construction financing, there are many factors that will determine if you qualify and what loan terms you’ll be offered. Key factors lenders consider include:

• Credit score – A higher score increases likelihood of approval and the best interest rates. Many lenders require 680+ for construction loans.

• **Debt-to-income ratio