What property buyers should know about land loans

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If you’re eyeing a piece of land to build a house on or to use for business purposes, you probably won’t be able to get a regular mortgage to finance the purchase. Instead, you’ll likely have to apply for a land loan.

Land loans aren’t as common as traditional mortgage loans, though, so there are fewer options. With less competition between lenders, you could face a bigger down payment requirement, a higher interest rate and less time to repay the loan than you would with a traditional mortgage. If you apply for a land loan, it’s important to know what you’re getting into and how to reduce your costs.

What are land loans?

A land loan is used to finance the purchase of a tract of land. There are a few different types of land loans depending on the type of property you want to buy:

  • Raw land typically doesn’t have access to utilities and has no improvements; it may not even be accessible by road. Raw land is generally more inexpensive than the alternatives, but it can be difficult to get financing.
  • Unimproved land may have access to some utilities but still lack some improvements, such as a phone line or a meter for gas or electricity. Obtaining financing for unimproved land is easier than for raw land, but can still be challenging.
  • Improved land is developed with full utility and road access. While it’s the most expensive type of land, it’s the easiest to finance.

Land loans are a very small slice of the lending market and tend to be riskier for lenders than mortgage loans, explains Casey Fleming, a branch manager with Fairway Independent Mortgage Corporation in Campbell, California. If a lender has to foreclose on a land loan, there’s no guarantee of recovering the money.

“Owners of raw land are much more likely to stop making payments and walk away from the property in the event of a financial event in their lives,” Fleming says. “If you own your own home, you’ll do anything you can to save it. With raw land, you can’t use it or generate any income off it.”

Vacant land is much harder to sell than a lot with a house on it because there is less demand for land than there is for already-constructed homes.

“Most people can’t handle buying land and building something on it,” Fleming says. “It involves a lot more time and money than people expect. Even if it’s a fixer-upper, people want something they can start with and work from there.”

While there are fewer institutions that extend land loans than other types of home financing, it’s still a good idea to shop around if you can to make sure you’re getting the best possible terms.

How do land loans work?

Some land loan lenders require a substantial down payment — ranging from 20 percent to 50 percent of the purchase price — and charge higher interest rates. Some land loans have significantly shorter repayment terms than a 15- or 30-year mortgage, as well, or other requirements, like a cap on the amount of acreage.

The process of applying for a land loan and receiving the funds, however, is somewhat similar to that of a typical mortgage. The lender will evaluate documentation of your financial situation and run a credit check, and you’ll pay the balance back with interest over a predetermined period of time. Some land loans are structured as balloon mortgages, with interest-only or no payments for a set time, then the balance coming due in one large payment.

“You may have to have a plan to pay it off before that payment comes due,” Fleming says.

5 types of land loans

1. Lender land loans

Community banks and credit unions are more likely to offer land loans than large national banks. Your best bet is to find a lender with a presence near the land you want to buy. Local financial institutions usually know the area and can better assess the value of the land and its potential.

If you don’t plan to develop the land, interest costs will be steep, Fleming says, and a lender could require a down payment as high as 50 percent.

As you would with any loan, shop around before you apply.

2. USDA Rural Housing Site loans

If you’re planning to build a primary residence in a rural area, the U.S. Department of Agriculture (USDA) has two loan options to consider:

  • Section 523 loans are designed for borrowers who plan to build their own home.
  • Section 524 loans allow you to hire a contractor to build a home for you.

Both loans are designed for low- to moderate-income families and have a repayment term of just two years. The interest rates, however, can be low. Section 523 loans, for instance, charge just 3 percent, while Section 524 loans charge less than the current market rate, with the rate on your specific loan fixed at closing.

3. SBA 504 loans

If you’re a business owner planning to use the land for your business, you may qualify for a 504 loan through the U.S. Small Business Administration (SBA). With a 504 loan, you, the SBA and a lender help contribute to the costs of the land purchase:

  • The SBA provides a loan for 40 percent of the purchase cost.
  • A lender provides a loan for 50 percent of the purchase cost.
  • You contribute 10 percent in the form of a down payment.

The interest rate on a 504 loan will be based on current market rates. The other terms of the loan can vary by lender, however.

4. Home equity loan

If you already have a home with significant equity, it might be worth getting a home equity loan instead of a land loan. There’s no down payment required on a home equity loan, and you can typically get a low interest rate regardless of what you plan to do with the land because your home secures the loan. Depending on the lender and the loan, the repayment term could be between five years and 30 years.

The big downside is that if you default on the loan, you could lose your home. Also, since you’re not using the loan to buy, build or substantially improve the home used as collateral, the mortgage interest you pay is not tax-deductible.

5. Seller financing

In some cases, the person or company selling the land might be willing to offer owner or short-term financing.

However, the typical seller isn’t in the lending business and doesn’t have a broad portfolio of loans like a community bank or credit union, so you can expect high interest rates and a hefty down payment. Also, it’s unlikely you’ll get a long repayment term. Consider this option only if you can’t qualify for any other type of land loan.

How much of a loan can I get for land?

There are no blanket rules for how much you can borrow with a land loan, and loan amounts can range depending on the type of land you’re purchasing and the mortgage lender you’re working with.

One lender might help you finance up to 85 percent of the cost of developed land, for example, or 70 percent of the cost of raw land. Keep in mind that how much you can borrow is directly related to how much cash you have and can put down on the transaction.

Land loan rates

Because land loans carry more risk, lenders tend to charge higher interest rates — upwards of 5 percent or 6 percent, and that’s just to start. Depending on the property and your down payment and creditworthiness, you could end up paying a higher rate than that. Because these loans tend to be more expensive, it’s all the more important to take your time to compare multiple lenders before you settle on one.

How to get a land loan

Before you start looking for a loan, Fleming recommends developing a comprehensive plan for what you want to do with the land. That can help you determine what type of loan and terms are best for your goals.

If you haven’t found a site yet, use websites like LandWatch, LandSearch and Land.com to search for properties based on your preferences and what you plan to do with the land. You can also use these sites to connect with a real estate agent who specializes in land purchases.

As with any other type of loan, it’s important to shop around. It can be a good idea to work with a broker experienced in land loans, but if you want to shop around yourself, one place to start is to see if you qualify for any of the government-sponsored loan programs. You might also want to get in touch with local lenders and credit unions, who could be more likely to extend you this kind of financing.

Run a quick search online to find land loan providers in your area. Make sure you read the requirements carefully and reach out to a loan officer to talk about your situation and your chances of getting approved.

Land loan pros and cons

Land loans are used in pretty specific circumstances, so they’re not useful for a huge share of homebuyers. Here are some ways they might make sense for you and some ways they won’t:

Pros

  • Simple way to finance a project if you’re buying an empty lot and building a new home for yourself
  • Government programs may help you get low interest rates with a small or no down payment requirement
  • Can help small business owners get established in a new location

Cons

  • May be difficult to find a lender
  • May be charged a high interest rate or need to tap your home equity if you don’t qualify for a government program, which could jeopardize your current property
  • Could have a short repayment period, which means high monthly payments until the debt is paid off

Taking out a land loan to buy and build from scratch isn’t for everyone, Fleming says — “but those who do are usually pretty satisfied when their project is finished.”

Next steps

If you already have a land loan secured and didn’t get it through the SBA or USDA programs, your next step is to connect with a construction loan lender. Check out Bankrate’s guides to home construction loans and some of the best construction loan lenders for more.

Learn more:

Written by
Zach Wichter
Mortgage reporter
Zach Wichter is a mortgage reporter at Bankrate. He previously worked on the Business desk at The New York Times where he won a Loeb Award for breaking news, and covered aviation for The Points Guy.
Edited by
Mortgage editor
Reviewed by
Robert R. Johnson
Professor of finance, Creighton University