Buying a piece of land to build a home or start a business on is an exciting prospect. However, land can be expensive and financing the purchase requires specialized loans. If you’re considering buying land, learning about loans to buy land is essential. This complete guide will cover everything you need to know about the types of land loans, requirements, where to find them, pros and cons, and alternative options.
What is a Land Loan?
A land loan, also called a lot loan, is financing used specifically to purchase a plot of land. Land loans work similarly to traditional mortgages in that the property serves as collateral, you’ll need to make a down payment, and repay the loan over time.
However land loans have some key differences
- They typically have shorter repayment periods of 2-5 years
- There’s often a large balloon payment at the end
- It can be harder to qualify and you’ll likely need a higher credit score and down payment amount
Land loans allow buyers time to plan construction of a home or business on the property, They differ from construction loans which provide financing for buyers who want to build immediately
Types of Land Loans
There are a few categories of land loans, based on the type of property:
Raw Land Loans
Raw land has no development or infrastructure. This is the riskiest type of land to build on, so raw land loans have strict requirements:
- Down payment of 35%
- Credit score over 700
- Detailed construction plan
- Higher interest rates
Unimproved Land Loans
Unimproved land may have limited infrastructure or old structures, but lacks utilities access. The down payment requirement is slightly lower at 25%, but credit score and plan requirements remain high.
Improved Land Loans
Improved land is development-ready with road access and utilities. This is the least risky loan option and requires only a 15% down payment in most cases. Credit and plan requirements are also more flexible.
Loan Qualifications
While requirements vary between lenders, here are some typical land loan qualifications:
- Down payment of 15-35%
- Credit score of at least 700
- Maximum 43% debt-to-income ratio
- Detailed plan for land use
- Recent appraisal and land survey
Having an excellent credit score and reasonable debt level compared to your income will improve your chances. Providing a solid construction plan also shows lenders you’re serious about developing the land.
Where to Get a Land Loan
Finding a lender willing to finance land purchases can be tricky, but you have several options:
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Local lenders – Community banks and credit unions are often most familiar with land values in the area. Farm credit associations also offer land loans.
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Specialty lenders – Some non-bank lenders focus specifically on land financing. They may offer more flexible requirements than local banks.
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Government programs – USDA offers land loans for low-income buyers in rural areas planning to build a primary residence. The SBA 504 loan provides land financing for commercial properties.
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Home equity – Those with substantial equity may qualify to cash-out refinance or take a home equity loan or HELOC to purchase land.
No matter where you apply, having pristine credit and a sizable down payment will boost your chances of approval.
Pros and Cons of Land Loans
Land loans allow buyers time to plan construction but also have some drawbacks:
Pros
- Finance land purchases without requiring immediate construction
- Opportunity to build dream home or business facility
- Lower rates and requirements for improved land
Cons
- High credit score and down payment requirements
- Short repayment terms with balloon payment
- Difficult to find lenders who offer them
- Higher interest rates than traditional mortgages
For buyers who can meet stringent requirements, land loans provide needed flexibility. But for those with less-than-perfect credit or limited funds, they can be difficult to obtain.
Alternative Options for Buying Land
If you don’t qualify for a land loan, here are a few other ways to buy land:
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Seller financing – The seller handles the financing directly. May offer more flexibility than lenders.
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Home equity loan – Tap equity you have built up in an existing home to purchase land.
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Cash purchase – Save up to pay all cash, if time allows. Avoid financing costs.
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Partnership – Team up with others interested in the land to split purchase costs.
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Crowdfunding – Use an online platform to raise funds from multiple contributors.
With the right preparation and financing strategy, buying land to achieve property ownership dreams is possible. Do your homework on the loans and options available in your area.
FAQs about Loans to Buy Land
How much does a land loan cost?
The exact cost of a land loan depends on the loan amount, your credit, and current interest rates. However, land loans typically have higher interest rates than traditional mortgages. Expect to pay 1-2% higher in interest with rates of 5-8% currently.
Should I build or buy a house?
Building a home on land you purchase allows you to customize features, but can cost 10-25% more than buying an existing home. Consider timeline, budget, and how long you plan to stay in the home when deciding.
What credit score is needed for a land loan?
Most lenders want to see a minimum credit score of 700-720 to qualify for a land loan. Those with scores in the mid-600s may still be approved but likely at higher rates. Excellent credit improves your rate and approval odds.
Can I get a land loan for raw land?
Yes, raw land loans are available but considered high-risk. To qualify, you’ll need pristine credit, a 35% downpayment, and a detailed construction plan. Improved land loans are easier to obtain than raw land financing.
How much down payment is needed for land?
Down payment requirements range from 15-35% depending on the land type. Raw land requires 35% down, while improved land needs only 15% in most cases. Coming up with a 20% or higher down payment will improve your loan terms.
What is the process of getting a land loan?
The process is similar to obtaining a mortgage. You’ll provide documents to show creditworthiness, income, construction plans, and make a down payment. The land serves as collateral, and you’ll repay the loan over 2-5 years.
The Bottom Line
Buying land to build or develop takes careful planning and financing. While land loans make owning vacant land possible, they have stringent requirements. For buyers who don’t meet qualifications, seller financing or tapping home equity could provide alternative routes to land ownership. With the right strategy, purchasing property to achieve landownership dreams can become reality.
Speculative Investment
Finally, there is raw land with no specific plans for any development. This would be considered a speculative investment.
For example, this could involve buying land in anticipation of the completion of a new freeway nearby. The hope would be that when the freeway is completed, the land would be attractive to a developer who wants to build a new subdivision with a convenient commute into the city. The land could then be sold to the developer for a tidy profit. Although the FDIC loan-to-value limit is 65%, lenders may feel compelled to require down payments greater than 35%.
Unimproved lots are ones that do not have basic required services such as water lines, electricity lines, or access to public roads. With such lots, it is common to run into unforeseen problems and cost overruns, which can add months to the purchase time line.
Build Immediately
The terms of the loans—such as down payment and interest rate—typically hinge on the intended use of the land since this is directly linked to the bank’s risk exposure. In this way, getting land loans is always trickier than buying an existing house since a current house gives the bank immediate, tangible collateral.
However, developing land immediately often has less risk than developing it later because fewer variables may arise to prevent development in the future.
The Federal Deposit Insurance Corp. (FDIC) has established lending policies for institutions regarding the loan-to-value limitations for land. All loan terms are up to each lender’s internal limits but should not exceed FDIC guidelines. Construction of a one- to four-family residence calls for a 15% down payment (or 85% loan-to-value limit).