Are you wondering how land loans work? Perhaps you are planning to buy land that will be a perfect fit for your future home? Obtain a loan for a land is a smart move, especially when you’re not building your house right away.
Obtaining land financing is a great way to make your purchase on time. You can take out a mortgage on land the same way you would a house – the only difference and downside is the valuation of the land. The value of land is more difficult to determine compared to a house.
Let’s take a look at everything you need to know about acquiring a home loan, to make your financing a hassle-free and easy process.
Where do you get your loan from?
Specific banks or lenders will grant you land loans. You can search for mortgage lenders by asking around, possibly a real estate agent, or by doing your own research online. Local credit unions are a great place to start. Very often, local lenders are an excellent source for finding land loans.
Once you find the lender of your choice, they will analyze your credit history as well as the market value of the land. Then they will make a final decision regarding your eligibility to purchase that land.
How to get land loans?
The process of obtaining your land loan takes many forms; this is because there are several types of loans. However, in all land purchase transactions, it would be best to have a good credit rating, good debt-to-income ratio, and ongoing income.
Land is considered a riskier investment than a building. This produces some consequences. First, you will have to pay more out of pocket for the down payment and the interest rate.
Second, land loans are usually only granted on a short term basis. The mortgage lasts only two to five years. If you buy this land to build a house, you might get a longer loan.
Types of land loans
As we mentioned earlier, the process for getting your mortgage loan varies depending on the type of loan you are applying for. Here are the most common types:
Loan of raw land
This applies if you intend to buy raw land; which means there are no upgrades or construction on it. There are no facilities either: no electricity, no sewers, roads, etc.
In this case, the risks are the highest for any lender. The risk increases in proportion to the time required to develop the land. Thus, this type of land loan is the most difficult to obtain.
You can expect high interest rates and larger down payment requirements. For the gross land loan, you will need to cover up to 50% of the amount. If you want to increase your chances of getting such a mortgage and get good terms, you need to present the lender with an elaborate and effective land use plan.
This is the right loan if you want to buy land with a certain level of infrastructure, such as gas, water and electricity. The land will most likely be used for construction development, which is a safer investment for lenders.
They will be more inclined to grant you the land loan under such conditions. The more land is improved, the better the chances of obtaining a land mortgage. Usually, the terms of the contract will also be more flexible.
Interest rates are lower than gross land loans due to less risk. You can expect the down payment requirements to be between 30-50% down payment.
Building land loan
If you are building a house right away, you would be much better served with a construction loan. Construction loans provide funds to build the house which is then turned into a permanent mortgage.
This guy is a two in one loan. You can apply for a loan that covers both the land you want to buy and the construction you want to develop on that land. However, this requires a great credit score (above 700), low debt to income ratio and high income, as well as construction development plans must bring real value.
In this case, you will still have a deposit of 10-20%. Construction plans should be made by a professional and reputable developer.
You must also present the precise construction schedule and the cost estimate. The lender might even recommend several reputable builders. If you work with them, your chances of getting a construction loan increase dramatically.
Keep in mind that the lender will periodically inspect and get involved in all stages of the construction. They will receive their money in multiple draws throughout the process. The drawing schedule is agreed between you, the lender and the builder.
This type of mortgage is short term, the average being one year. During the construction period, you will pay interest; then the loan is transformed into a real estate mortgage, for a period of 15 to 30 years. The house can be either a modular construction or a traditional house built from sticks.
Generally, all types of land loans are considered risky by any lender. So you can expect high interest rates from the start. A good credit history gives you hope for better interest rates.
To give you a general idea, here are the average rates for a 10-year loan and a 30-year loan, respectively:
– For gross loans: 4.25-5.25% / 4.90-5.90%
– For lot loans: 4-5% / 4.65-5.65%
– For construction loans: variable rate (around 5.25%)
Choose the land
You have a better chance of getting a land loan if you take several land considerations into account:
– The limits: they must be very well defined. It helps establish the value of the land. Usually, lenders require a land survey before deciding if you are eligible or not.
– Restrictions: Lenders want to know if the land is part of various associations or property agreements. With that comes responsibilities they might not be willing to take on.
– Utilities: The more there are, the better it is for your land to make a good impression with your lender. They appreciate access to paved roads, electricity, gas connection, sanitation. If any of them are missing, present your lender with a detailed plan to add them.
– Targeted development: The value of the target land increases if the whole area is under development, such as if there are plans for shopping malls, residential buildings, highways, etc. Present all of this to your lender and you will quickly get your land ready.
Land loans provide an excellent financing opportunity for those who wish to purchase land to possibly build their dream home or create a business opportunity. You should now have a much better understanding of how home loans work.
Bill Gassett is a nationally recognized real estate leader helping people buy and sell MetroWest Massachusetts Real Estate for 33 years. It has been one of the best RE / MAX REALTORS® in New England for the past decade. In 2018, he was the number 1 RE / MAX real estate agent in Massachusetts.