Loans to Buy Land and Build a House: The Complete Guide

Buying land and building a custom home from the ground up is an exciting prospect for many homeowners. Having full control over the design and layout of your house along with selecting the perfect location makes this option very appealing. However, financing the purchase of land and construction of a new house requires careful planning and research into specialized loan programs. In this comprehensive guide, we’ll explore the ins and outs of the various loans available to buy land and build a house so you can make the best decision when embarking on building your dream home.

Overview of Construction Loans

Construction loans are specifically designed to finance building a house on purchased or owned land. This type of financing covers purchasing the lot, paying contractors, purchasing materials, and other costs associated with home building. Construction loans have unique qualifications and terms compared to standard mortgages.

There are several types of construction loans offered by private lenders, government agencies, and non-profit organizations. We’ll take an in-depth look at various loan options below.

Important Factors When Choosing a Construction Loan

Before diving into the specific loans here are some key factors to consider when researching construction loan programs

• Downpayment requirements – The downpayment for a construction loan is often higher, frequently 20% or more of the total costs. However, some loans like USDA and VA offer 100% financing.

• Interest rates – Construction loans often have higher interest rates than traditional mortgages but can vary significantly between loan types. Interest rates on construction loans are usually adjustable, not fixed.

• Credit score requirements – Construction loans tend to have higher credit standards given the increased risks associated with building a home. Scores of 620 or 640 are common minimums.

• Loan term – Many construction loans convert into permanent mortgages once the home is completed, often requiring refinancing. Others feature both short-term construction financing and a long-term permanent mortgage.

• Special requirements – Construction loans can have additional requirements related to builder qualifications, spending draws, municipal approvals, zoning, and inspections.

Types of Loans to Buy Land and Build a House

Below we outline details on the most common construction loan programs for buying land and building a new home:

USDA Construction Loans

• Overview: Loans issued by qualified private lenders and backed by the U.S. Department of Agriculture Rural Development. Feature a single-close construction loan covering land, building costs, and permanent mortgage.

• Ideal for: Low to moderate income borrowers in rural areas. Offers 100% financing.

• Considerations: Limited availability, higher interest rates, and stricter qualifications. Can be difficult to find participating lenders.

FHA Construction Loans

• Overview: Issued by private lenders and insured by the Federal Housing Administration. Feature a single-close construction loan with low down payment options.

• Ideal for: First-time and lower income buyers. Down payments as low as 3.5%.

• Considerations: Require upfront mortgage insurance premiums. High demand results in limited availability.

VA Construction Loans

• Overview: Backed and guaranteed by the U.S. Department of Veterans Affairs. Offer 100% financing and flexible terms for qualifying veterans.

• Ideal for: Military service members and veterans. No down payment required.

• Considerations: Must be eligible for VA home loan benefit. Shorter loan terms than other options.

Conventional Construction Loans

• Overview: Offered by private lenders like banks and credit unions. Down payments around 10-20% with stricter approval criteria.

• Ideal for: Borrowers with established credit history and moderate down payment funds.

• Considerations: Higher qualification standards, varying interest rates, and larger down payments required.

Owner-Builder Construction Loans

• Overview: Designed for borrowers acting as general contractors for new home construction. Require hands-on involvement.

• Ideal for: Experienced builders able to manage construction process. Allow sweat equity to offset costs.

• Considerations: Require broad construction knowledge and project management skills from borrower.

Steps to Obtaining a Construction Loan

If a construction loan is right for your home building plans, here are the typical steps to obtaining financing:

• Research lenders and loan programs available in your area and for the property. Compare interest rates, terms, fees, and qualifications.

• Get pre-qualified to determine the loan amount and programs you may be eligible for based on your financial profile.

• Select a lot and finalize new home plans with a builder or architect.

• Submit the construction loan application along with plans, permits, and other documents to the lender.

• The lender will appraise the land and proposed home plans. You may need to provide a down payment and pay loan origination fees.

• Once approved, a construction loan agreement will specify financed amounts, inspection requirements, disbursement schedule, and conversion to permanent financing.

• A series of inspections will occur over the construction period prior to the lender releasing scheduled draw payments to the builder contractor.

• Once construction is complete and you have closed on the home, the lender will convert the construction loan into permanent financing.

Pros and Cons of Construction Loans

Construction loans make building a custom home more feasible, but also come with some drawbacks to weigh:

Pros

• Finance cost of land purchase and all construction costs
• Feature interest-only payments during building phase
• Convert to permanent mortgage in one closing
• Lower down payments available on some loans

Cons

• Often have higher interest rates
• Require meeting stricter qualification standards
• Have lower loan-to-value ratios for financing
• Involve paying multiple sets of closing costs
• Require managing the construction process

Alternatives to Construction Loans

If construction financing does not fit your situation or needs, here are a couple alternatives to consider:

• Bridge Loans – Shorter term financing to purchase land before obtaining a standard mortgage to finance building a home. Require two separate closings.

• Renovation Loans – FHA and other loan programs to purchase and renovate an existing home over time. Feature flexible terms and expanded financing options.

• Personal Loans – May be used short term to cover land purchase and initial construction costs before seeking permanent mortgage financing.

• Home Equity Loans – Tap available equity in an existing home to finance buying land and constructing new home. Require paying off when old home is sold.

Key Takeaways

• Construction loans allow buyers to finance land acquisition and building costs in a single loan product with variable interest rates and flexible terms.

• Government programs like FHA, VA, and USDA offer construction loans with lower down payments for qualified borrowers. Conventional loans require 10-20%.

• The loan application process involves finding a lender, getting pre-qualified, submitting an application with permits/plans, financing approval, scheduled construction draws, and conversion to permanent mortgage.

• Construction loans make custom building more affordable but also come with higher rates, stricter qualifications, lower financing, and increased responsibility managing the build process.

Careful research and comparison of the construction loans available are important when planning to buy land and build your dream home. Partnering with an experienced lender can help navigate what is often a complex process. With proper planning and the right financing, you can fulfill your vision of a custom-built home in the location you choose.