Would you like to know how land loans work? Prospective home buyers may also consider constructing a house when they seek to buy a house.
The idea may appear ideal until future homeowners learn how much it will cost to build a house.
Though constructing a home might be costly, several methods exist to make it more affordable for first-time buyers. One of these resources is land loans.
If you decide to build a house, you may need to apply for a land loan. Acquiring a land loan is more complicated than obtaining a mortgage.
If you buy land rather than an existing house and plan to construct it from scratch, you’ll probably require a land loan.
This creates more issues than obtaining a regular mortgage. For starters, there is no home to provide security for the land loan, and you cannot (typically) acquire land with no money down.
Obtaining land finance presents new challenges for prospective purchasers. Here are three things to consider before purchasing land.
KEY LESSONS
• Obtaining a land loan presents particular problems compared to obtaining a mortgage on a home.
• For example, because lenders want surveyed borders, you’ll need to investigate the property’s zoning and land-use limitations and access to utilities and public roadways.
• A buildable lot will reduce your financing costs compared to one that is not.
• Seller financing, local lenders, or a home equity loan are the best options.
• Rural property may be eligible for a USDA-subsidized loan.
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What Exactly Is A Land Loan?
A land loan, also known as a lot loan, is used to finance the acquisition of a plot of land.
You can get a land loan if you want to acquire a piece of land to build a house or use for commercial purposes. The type you choose will determine where you purchase land and how you want to utilize it.
A land loan is sometimes mistaken for a construction loan, which is another type commonly utilized by those who want to build a house.
So, what’s the distinction? A construction loan is typically required if you wish to acquire land and begin constructing on it immediately.
These short-term loans are meant for potential housebuilders eager to get started on their projects and have everything ready.
On the other hand, land or lot loans are preferable for prospective home builders who have a concept but do not want to rush into the building and finance a house.
If your building project is delayed by a year or more (or you’re still putting together your home designs), a land loan is probably a better option.
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What Is The Process Of Obtaining A Land Loan?
Like any other type of lender, lenders want to ensure you can repay a land loan. Most lenders examine your credit score to determine how much debt you have and how well you pay it back.
You’re fantastic if you’re debt-free and don’t have a credit score! Your lender will perform manual underwriting, examining your income, savings, and general financial situation.
Manual underwriting is far superior to receiving a loan based on your credit score since it considers how much money you have in the bank.
(A credit score is essentially an “I love debt” score, which is why they’re worthless!)
Now comes the part when land loans differ: You must inform the lender of your plans for the land.
So, if you want a residential lot loan, you must specify if you wish to build a house immediately or first rehabilitate the site.
You must also inform the lender of any unknowns, such as how the property is zoned, whether there are any land-use limitations, or if utility access is available.
They’ll use that information to determine whether or not to grant you money and set the land loan conditions.
This covers the interest rate, the number of years you have to repay the loan, and the amount of the down payment you must make.
Land loans are often seen as riskier by lenders than housing loans. As a result, land loan interest rates are usually twice as high, and (as previously stated) most lenders need larger down payments—at least 20%.
Different Types Of Land Loans
Loans for Undeveloped Land
The site is said to be entirely undeveloped, with no power, sewerage, or even roads. You should check into raw land loans to use this property for construction.
This sort of land is challenging to finance. You’ll need to create a plan so the lender understands precisely what you intend to do with the property and can be convinced you comprehend the work.
This is to avoid financial danger since you will appear dedicated to the project if you do this.
While this land is less expensive, the big down payment and high interest rates might make this loan unattainable for many first-time buyers, especially those with low credit.
These loans are frequently employed by property developers who want to build a subdivision.
Loans For Unimproved Land
Unimproved land is more developed than unimproved property and includes utilities and facilities. It still lacks essentials such as electric and natural gas meters.
While an unimproved land advance is not as challenging as a raw land advance, it might not be easy to achieve.
So, ensure you have a thorough strategy, a significant down payment, and a good FICO credit score.
Because unimproved land loans aren’t the riskiest loans a lender can provide, the upfront payments and financing expenses won’t be out of this world.
However, it is not unusual for them to be greater than other financing loans. That is how unimproved land loans operate.
Loans From The USDA
USDA and FSA loans are available to acquire land, animals, equipment, feed, seed, and supplies. USDA loans can also be used to build structures or enhance farms.
Better Land Loans
Unlike the previous two loans, this land generally has access to power, water, and roads.
Because of everything I described above, this is the costliest land to obtain for someone wishing to build their dream house.
The advantage of financing this land is that interest rates and down payments are much more affordable because it is less risky from a lender’s perspective.
Like with any loan, it is still desirable to have a strong credit score and make a significant down payment to boost your chances of being accepted.
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How To Apply For A Land Loan
Obtaining a land loan is more complicated than obtaining a conventional home loan. Lenders will prefer that you have more money upfront and are better qualified (which means having a high credit score or a big savings account).
If you qualify, the procedure of obtaining a land loan is identical to that of obtaining a home loan.
As with any other loan, you should begin by narrowing your search parameters.
What kind of property are you searching for? What do you intend to do with it? What is your financial situation?
Once you’ve decided on these variables, you may apply for a land loan preapproval.
You won’t spend time rushing back to the lender or discovering you can’t afford a home that way.
When you’re preapproved, you’ll know precisely how much you can pay and can promptly make a bid on the land you want.
That said, you might want to reconsider being authorized for a land loan—despite their name, they’re not the best option for acquiring property.
The Pros Of Building A House
After you purchase the property, you will likely want to construct something on it. So, is it better for you to build a house? There are several reasons why it may be the best solution for you.
To begin with, you can choose practically everything: colors, layout, countertops, and flooring. Thus, you’ll have a home completely tailored to your tastes and preferences.
If you buy an existing house, it will likely not be precisely the way you want it.
Before you feel comfortable in your house, you may need to conduct cosmetic work (painting, flooring) or improvements (knocking down a wall, changing cabinetry).
When you build a house, you may incorporate whatever upgrades you choose. For example, you can decide whether granite worktops or radiant floor heating are worth the price.
Of course, improvements might significantly increase your prices, so be sure they fit inside your budget.
But it’s not just about money. Newly built homes also offer some cost savings in energy efficiency.
When you build a house, you will have brand-new appliances, lights, HVAC, plumbing, electrical, and other systems.
They will be more energy efficient than versions from a few years ago, which can result in annual savings of hundreds of dollars.
And you’ll be moving into a brand-new home no one else has ever lived in.
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The Cons Of Building A House
Even if it’s your ideal residence, building a house has cons.
The most significant disadvantage is the cost. It’s easy to get caught up in the excitement of home construction and misjudge how much it costs to build a house, going over budget with modifications and extra features.
If the construction is delayed or has problems, you may incur additional expenditures over which you have no control.
Another significant disadvantage of building a house is the timetable. Waiting for a home to be built will take significantly longer than closing on an existing property.
Construction may not be the best option if you need to move into your house by a specific date.
The Benefits And Drawbacks Of Land Loans
Pros
You may create your ideal home. Rather than purchasing an existing home, buying property allows you to start from zero and build a new home precisely how you want it.
Build on your schedule. If you choose a raw land loan, you can keep the property for several years before beginning the building process. However, building financing may not provide this opportunity.
Construction is simplified with single-close alternatives. If you’re ready to build, construction loans can finance your land purchase and the new building cost, then convert to a regular mortgage when you’re prepared to move in. You’ll have to close once, making the procedure simpler.
Cons
Raw land may be more challenging to sell. Purchasing land might be riskier than buying a home, mainly if the economy is not thriving.
Land does not rise in value as much as renovated property. When economies become soft,’ land sells more slowly than upgraded property.”
The land may not be suitable for construction. If you intend to construct, you must guarantee that the property can sustain a home in the future, especially if you are purchasing unimproved ground. This isn’t always true.
You’ll have to meet more stringent qualifications. Obtaining a land loan is frequently more difficult than obtaining a regular mortgage.
You’ll likely need a higher credit score and a larger down payment to qualify.
Loans might be challenging to come by. Not all lenders provide land loans; you may need to browse for a while to get a decent deal.
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How To Select A Land Loan
Lenders are more likely to support less hazardous, less expensive, and more straightforward initiatives. The following elements may assist you in obtaining a land loan:
Boundaries And Surveying
A survey is essential to avoid future legal issues and to provide a clear image of precisely what land will be yours.
It would be best if you surveyed purchasing land to ensure that you understand the boundaries of your property.
Most lenders require a thorough American Land Title Association (ALTA) boundary survey before approving a land loan.
Utilities
Check to see if the land has services such as sewage, paved roads, power, and water.
While most land will have access to these goods, if you lack any or are buying raw land, make sure you have or can get the budget, appropriate licenses, and land space and comply with state and local rules and health codes.
Zoning And Constraints
Depending on your intentions for your property, you must confirm that the zoning permits you to finish your project legally.
For example, if you’re looking to buy property to build a house, be sure it’s zoned for residential use.
Read up on any additional special restrictions that may apply to your land and what you may and cannot do.
Wildlife And The Environment
Do not intend to construct on land protected by the US Fish and Wildlife Service due to endangered plants or wildlife species.
Furthermore, states frequently have longer lists of protected flora and animals.
However, this may be good news since you may be eligible for government funds to safeguard endangered species, do less harm, and support the environment during development.
Finally, be aware of any environmental problems to prepare adequately.
Future Modifications
Is any building planned near your property, such as a new roadway, school, or commercial center?
The construction of new facilities can impact the value of your property; therefore, incorporate such concerns and research in your planning to guarantee that your land continues to satisfy your demands.
Alternative Land Purchase Options
If you want to buy property but are hesitant to take out a land loan, explore these other options that may better suit your circumstances.
Home Equity Line Of Credit
Home equity loans vary from land loans because they may be a more appealing alternative for some borrowers.
They function as a “second mortgage,” allowing you to use part of the equity you’ve accumulated in your current house.
They don’t demand a down payment, and because your home secures the loan, they can generally lock in a cheaper interest rate regardless of what you plan to do with the property.
Furthermore, the interest you pay is not tax-deductible because you are not utilizing the loan to buy, develop, or enhance the home used as security.
Depending on the lender, the loan payback time might range from 5 to 30 years.
Unfortunately, you may lose your house if you do not repay the loan. Rocket Mortgage does not currently offer home equity loans.
Financing From The Seller
Seller financing may also be appealing to some borrowers. Seller-financed land deals are also known as land contracts.
These are real estate contracts where the seller is a lender and directs the mortgage process rather than a financial institution or lender.
The buyer contracts with the seller rather than applying for a regular mortgage.
This method may be advantageous for purchasers since sellers are more flexible than financial institutions. A seller-financed loan may be simpler to qualify for than a typical loan.
Seller financing can benefit ambitious land purchasers who may be unable to qualify for a land loan or afford a significant down payment, but it also has drawbacks.
Legal homeownership can be a murky area when paying for a seller-financed house. While you obtain equitable title, your seller will keep legal title to the property until you pay it off, which might present issues.
Furthermore, your vendor may charge you higher interest rates, and your contract conditions may be ambiguous.
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Construction Loan vs. Land Loan
A land loan is solely used to buy land, not to build a house. If you do not intend to create a home immediately, a land loan may be just what you want.
However, a construction-to-permanent loan is a better alternative if you want to acquire property and build immediately.
That’s a single closure mortgage, where you close on the property and commission the project simultaneously.
You may simultaneously buy the property and acquire financing to build your house.
Research recommends a construction-to-permanent loan to build a home within two years of purchasing the land.
A construction-to-permanent loan is a construction mortgage that automatically converts to a standard mortgage after the house is finished.
Construction loans work similarly to a line of credit in that you are accepted for a specified dollar amount with a variable interest rate and have a defined period, generally a year or two, to spend that money to build your home.
A construction loan requires an initial payment for the land and the constructor. The builder might make three or four draws on the construction financing.
These draws are often arranged in advance and correspond with milestones such as the foundation, frame, or roof completion.
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Final Thoughts
If you want to build a house, consider the advantages and disadvantages of a land loan to see if it’s appropriate for you.
While the idea of building your dream house sounds terrific, knowing the realities of obtaining a land loan or lot loan is critical.
Obtaining a land loan is more complicated than obtaining a regular mortgage since purchasing land is not as simple as buying a home.
Many banks and credit unions do not readily grant land loans. So, you must be extremely clear about the property you intend to buy and be prepared to produce surveys and zoning information regarding the site you plan to build on.
If you currently have a land loan but did not obtain it through the SBA or USDA programs, your next step should be to contact a construction loan provider.
To learn more, consult Bankrate’s guides to home construction loans and some of the top construction loan lenders.