Using Land as Down Payment for Construction Loan

Building a new home can be an exciting yet daunting process. One of the first steps is securing financing for your new construction through a construction loan. When it comes to making the down payment on a construction loan, many homeowners wonder if they can use the land they already own as a down payment instead of coming up with cash. This financing method is known as using land as down payment or “land in lieu financing”.

What is Land in Lieu Financing?

Land in lieu financing refers to using the equity you have in land you already own as the down payment for a construction loan instead of making a cash down payment. If you own land free and clear with no liens or mortgages, you likely have equity that can be leveraged. Rather than selling the land and using the profits for a down payment, you use the land itself as collateral for the construction loan.

How Does Land in Lieu Financing Work?

There are a few ways land in lieu financing can work

• Use land equity as part of down payment: If your land equity covers the full down payment amount, it can be used entirely in lieu of a cash down payment. If it only covers a portion, it can be used to lower the cash amount needed.

• Take out loan against land: You can take out a separate loan against the land, using it as collateral, and use those loan funds as the down payment on the construction loan.

• Land as collateral for construction loan With a one-time close construction loan, the land itself directly serves as part or all of the collateral for the construction loan, removing the need for a down payment

What Are One-Time Close Construction Loans?

One-time close construction loans, also called all-in-one or construction-to-permanent loans, are a popular option for land in lieu financing. Here’s how they work:

• The construction loan and permanent mortgage are wrapped into one loan.

• Your land is used as collateral to secure the construction loan.

• You only go through one loan application, approval, and closing process.

• The loan is converted from a construction loan to a regular mortgage once construction is complete.

One-time close loans allow you to avoid having to refinance into a separate mortgage after construction. This saves money on closing costs. Many also allow you to lock in one interest rate for the entire loan term.

What Are the Requirements for Land in Lieu Financing?

To qualify for land in lieu financing, there are a few requirements:

• You must own the land outright – The land must have no existing mortgages or liens. The title must be completely in your name.

• The land must appraise for enough – The land value must appraise for enough to meet the lender’s down payment requirements, often 20-30% of total project costs.

• Good credit and income – You’ll still need good credit, income, and debt-to-income ratios to qualify for the overall construction loan.

• Construction budget – Lenders will review your construction budget to ensure it’s realistic and you have funds to complete the project.

• Experienced builder – Having a reputable and experienced general contractor will make approval easier.

The Land in Lieu Financing Process

If you want to use land in lieu financing, follow these steps:

• Check for liens – Review property records to make sure no old liens still exist on the land.

• Get land appraised – Have the land professionally appraised so you know the equity amount available.

• Find a lender – Shop construction loan lenders, looking for one experienced with land as down payment.

• Apply for loan preapproval – Go through the loan preapproval process early.

• Provide documentation – Be ready to provide land deeds, contractor information, budgets, and all financial details.

• Close on loan – If approved, close on the construction loan and start your build!

Pros and Cons of Land in Lieu Financing

Pros

• Allows you to leverage land equity without selling land
• Avoids need for large cash down payment
• Wraps construction and mortgage into one loan
• Can provide financing even with less savings

Cons

• Requires owning land free and clear
• Land must appraise high enough to meet down payment requirements
• May require higher credit scores/income than conventional loans
• Can make loan approval more challenging

Alternatives to Land in Lieu Financing

If land in lieu won’t work for you, here are a few alternatives to explore:

• Sell land to get cash for down payment: Selling land you own is one option to generate a down payment. But you lose the land asset.

• Borrow from 401k: You may be able to borrow against your 401k balance for a down payment. This avoids early withdrawal penalties but you lose retirement savings.

• Piggyback loan: You can pair a first mortgage with a second “piggyback” mortgage to cover the down payment amount.

• USDA or VA loans: Government loan programs like USDA and VA loans allow 0% down financing options for eligible borrowers.

• Owner-builder construction: You can act as owner-builder to save on construction costs and lower the down payment needed. But this is very labor intensive.

Is Land in Lieu Right for You?

Land in lieu financing can be a great way to leverage your land equity to finance new home construction rather than selling land or taking cash from your savings. But make sure to explore all your down payment options, and consult experienced lenders to see if you qualify. With the right preparation, land equity can go a long way in making your dream home a reality.