The first thing to consider when purchasing land is the type of land. This isn’t a physical description of the land, like graded, hilly, or forested, but rather how it’s classified. Raw land and lot land are the most common types available. Lot land is intended for residential or commercial development and may have access to roads or easements in place and access to utilities like gas, electricity, and water. It’s likely that a survey has been done to accurately determine property boundaries. The appropriate zoning of the property may already be done as well. Raw land is just land, and it may or may not be suitable for development. This is why borrowing on lots is simpler and easier than raw land loans.
Where does it get complicated?
Often, land loans are just the first step to financing a whole new-construction project. By the time everything is complete, you’ll have used three different loan products – a land loan, a construction loan, and finally a consolidation loan. There may be administrative and closing costs associated with each loan separately, and a lot of paperwork to keep track of. If you’re working with separate lenders for the land and the construction, make sure that your purchase contract for the land spells out your options for cancelling in the event that you can’t secure construction financing.
How does a land loan work? What to expect when working with a lender:
When financing a land purchase, you’re going to need to meet credit qualification requirements set by the lender as well as make a down payment on the contract. These guidelines will vary from lender to lender since there is no industry standard when it comes to underwriting land loans. Generally, the better your credit profile and the more money you put down, the easier and less expensive the process will be. Lending on land puts land loan providers at a bit of a disadvantage when it comes to collateral, because no tangible improvements have been made to property yet and land values themselves can fluctuate. They offset this additional risk by requiring down payments, and holding borrowers to certain credit standards. And often price land loan interest rates at a premium. Government-backed loan programs are the exception to the rule. Banks that offer land loans can reduce the financial risk posed to secondary investors (the eventual purchasers of the loans) and are therefore able to offer low or no down payment land loan options.
What types of land loans are available?
Simple land financing is often available through commercial sellers and land brokers. No construction or improvement plans are necessary, as the land purchase is the entire transaction. The land itself is the collateral, and loan terms and payment plans are set forth in the contract. These loans are relatively short-term financing, usually repaid over 3 to 5 years. Once all payments have been made, the deed is conveyed to the new owner and recorded with the local county office. Any subsequent property improvements or construction will have to be financed separately.
Fannie Mae and Freddie Mac both offer construction conversion mortgages, designed to wrap up lot/land purchases and construction financing into a single-closing transaction. It’s still necessary to have a land contract in place, and detailed construction plans and cost estimates, as the end goal for these types of loans is to create a conventional mortgage on the property once acquisition and construction are complete. This means that all of the regular lending guidelines must be followed, especially when it comes to creditworthiness and ability to repay the loan. It is worth noting that these loan programs are available for primary homes, second homes, and investment properties. All of the following government-backed loan programs are only available for primary homes (FHA, USDA, and VA loans).
The FHA created 203(k) rehabilitation mortgages primarily for existing homes, however a property can be completely demolished or razed all the way back to a lot and rebuilt as long as some of the foundation remains intact. All FHA property guidelines apply to the new construction, and certain restrictions prevent so-called luxury improvements like installing a new pool or building a tennis court. The benefits of using an FHA loan include reduced down payment requirements compared with conventional loans, lending based on up to 110% of the improved value, and access to an FHA approved 203(k) consultant to help oversee the project. The minimum down payment contribution is 3.5%, as it is with other FHA loan products, and regular mortgage insurance requirements still apply. Upfront Mortgage Insurance Premium (UFMIP) is calculated as a percentage of the loan amount and the monthly Mortgage Insurance Premium (MIP) is paid along with the monthly payments.
The USDA offers loans in specifically designated rural or semi-rural areas. These loans can be used to build, repair, renovate or relocate a home as well as to purchase and prepare lots. This even includes getting utilities like water, sewer, and electricity to the site. USDA guaranteed loans allow for reduced down payments, all the way up to 100% financing, with no maximum loan amount restrictions, only the “ability to repay” requirements. Instead of mortgage insurance, there is a one-time upfront USDA guarantee fee, which is a percentage of the loan amount, and an annual fee that is financed along with the monthly payments. Section 502 single-family housing guaranteed USDA land loans are offered directly from the USDA and are only available to help low-income individuals or households.
Veteran’s Administration (VA) loans allow for land purchase and construction in a single transaction. These loans are only available to eligible military veterans and their families. As with traditional VA loans, an upfront funding fee is charged to non-exempt borrowers, and it is calculated based on first-time or subsequent usage of a VA loan. There is no monthly mortgage insurance premium, regardless of the loan to value; 100% financing is allowed. The VA doesn’t require lenders to offer certain products and programs though, so it can be difficult to find VA land loan lenders and contractors who are willing and able to meet the rigorous standards and demands of the VA.
Simple steps to make getting a land loan easier:
1. Be very thorough in your research of potential properties. The goal is to avoid unpleasant or expensive surprises, so seek out information from county records, geological surveys, and consider getting a flood certification done as well. Consider visiting the property at different times of the day, and during different seasons as well if you have any weather related concerns.
2. Determine a wants and needs list that focuses on things like the shape and size of the lot, any easements or covenants in place, access to roads and utilities, and nearby amenities. All of these factors can affect the value of the property in the long term.
3. Get your finances in order. If you’re planning on making a down payment, set these funds aside in a single account without much activity at least 60 days in advance. It will make the funds easier to source. Don’t take on any new debts ahead of your land purchase. Maximize your credit scores by keeping your utilization percentages low, and pay balances down as much as you can.
4. Create a budget based on your goals, and stick to it. Often, land purchases are just the first step in the whole home construction process. Having a vision and a budget for the project as a whole ensures that you don’t overpay in the early stages and have to make cuts or compromises later on.
5. Consult with lenders about their product offerings and requirements to find the best fit for your unique scenario. The terms and types of land loans vary from lender to lender. You may find that land financing is also offered by the seller, or by a construction lender who is able to take care of both loans concurrently.
6. Prepare for the loan process by gathering all your financial documentation. As with traditional mortgage loans, your ability to repay a land loan is determined by your income, assets, and credit. Expect to provide lenders with basics like pay stubs, W2 forms, and bank statements. Be ready for additional information requests, as there’s no set of overarching guidelines for lenders when it comes to land loans.
7. Ensure that your land purchase is recorded with the appropriate local government office, and that all taxes have been paid. Unimproved land does incur property taxes each year, so making sure that your deed is recorded properly and that you receive timely billing statements is essential to remaining current on everything.
8. Make full, on time payments once the loan is finalized. Just as with mortgage loans, land loans can fall into delinquency and default that could lead to foreclosure. Follow the repayment instructions set forth in your closing documents, and keep records of payments for at least two years. If the land loan doesn’t report on your credit, you’ll need this information available when you go to secure construction financing or any other mortgage loan (even if isn’t related to this property).