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Buying land and building a new home on it isn’t as straightforward as purchasing an existing home, especially when it comes to financing. While paying cash is an option for some, there are also loans that can help cover the cost of a land purchase, including a home equity loan.
Using a home equity loan to buy land
If paying cash or obtaining a land loan isn’t an option, you might be able to use a home equity loan (a second mortgage) to buy land. When you take out a home equity loan, you’re borrowing money against the equity you’ve built in your property. That means that property is collateral for the loan. If you don’t repay it, you could lose your home to foreclosure — a risk not to take lightly.
You can use the funds from a home equity loan for any purpose: buying the land, hiring a contractor and more. Depending on the loan term, you might have as much as 30 years to repay it with interest, similar to a 30-year mortgage for a home purchase.
Pros and cons of using home equity to buy land
|A home equity loan has a fixed interest rate, so you’ll be able to budget for predictable monthly payments.||Home equity loans provide only a set amount of funds, so if you end up needing more money for the purchase, you’ll have to find a supplemental source of financing.|
|It might be easier to qualify for a home equity loan compared to other financing options.||If you can’t repay the home equity loan, you could lose your current home.|
|If you plan to build a home on the land, you might be able to deduct the interest on the home equity loan.||Land doesn’t always increase in value, which presents more risk for you as the borrower and your lender.|
What to consider before buying land with home equity
Most land buyers use the property for residential purposes. In fact, in 2021, residential land sales represented 59 percent of all land sales, according to a report by the National Association of Realtors and Realtors Land Institute.
Consider what you’ll use the land for and whether a home equity loan is the best form of financing to make that happen. For example, aspiring farm owners might prefer to start with raw or vacant land, whereas those looking to build a home are likely looking for developed or improved land connected to main utilities and roads. The upper limit you can borrow with a home equity loan is typically 85 percent of your equity (sometimes just 80 percent), and developed land is generally more costly than raw land.
There are also many other expenses beyond the price tag of the land, including a land survey and title search, in addition to the costs to build a home once you’ve purchased the land it’ll sit on. All of these can be paid for with a home equity loan, but you’d need substantial equity to cover everything involved in the land purchase and construction.
Land values by state
Land values vary drastically across the U.S. depending on location (for example, rural versus urban), proximity to facilities, local market conditions and other factors. Here are estimated land values per acre in each state, according to the U.S. Bureau of Economic Analysis.
Alternative land financing options
A home equity loan isn’t the only option for buying land. Consider these alternatives:
Construction loans are short-term loans meant for those building a new home. The loan can be used for various project-related expenses, including land, permits, materials and labor. Typically, you draw down funds from the loan as needed as the project moves along, then convert it to a permanent loan and repay it in a similar way to a traditional mortgage. To qualify, you’ll need to provide the construction loan lender with a project plan that includes your budget and timeline, in addition to making a significant down payment or having other assets in the bank.
Simply put, these loans help borrowers purchase land, but they aren’t as common as construction loans. Depending on how the loan is structured, you might need a hefty down payment (more than 20 percent) and to contend with a shorter repayment period. In some cases, you might need to put up home equity as collateral, or demonstrate that the property meets the appropriate zoning and land-use requirements.
Borrowing money to buy land comes with risks, especially if you’re putting your home on the line with a home equity loan. Begin by comparing home equity loan rates and explore whether cash or a construction or land loan might be a better fit.