Land Loans: Defined And Explained

When home searching leaves you wanting more control over what your house will look like and where it’ll be located, why not just build the exact home you want exactly where you want it? For many, the search shifts from the perfect houses to the perfect plot of land where you’ll construct a home that’s just right for you.

To purchase that land, you’ll likely need a loan. It’s not entirely different from getting a loan for an existing house, but it’s not entirely the same, either. Understanding the nuances of land loans will help put you on a path to a smooth land acquisition process.

What Is A Land Loan?

A land loan, sometimes referred to as a lot loan, operates similar to a traditional mortgage loan for an existing home. You borrow money from a lender to buy land and pay the loan back over time. Traditional mortgage components like principal and interest are also present with land loans.

Since there’s no physical home yet, the house can’t be used as collateral, like it would for a mortgage. And, usually, you must put money down to acquire a land loan. There are various types of these loans available, depending on the location, condition and your intended use for the land you’re purchasing. For example, if you’re interested in buying rural property there will be a number of specific nuances to acquiring a land loan to do it.

Land loans are often confused with construction loans, but they are not the same. A construction loan allows homeowners to finance the cost to build a new house or renovate their home. Construction loans are short-term, typically a year, and come with higher interest rates than a traditional mortgage. Land loans are just for buying land.

How To Get A Land Loan

Getting a land loan starts with finding a lender that offers them – because not all do. For example, our sister company, Rocket Mortgage®, does not offer land loans. And since they aren’t offered everywhere, you’ll want to be sure to research which lenders can help you. Credit unions, banks and mortgage companies are good places to start. No matter which lender you choose, they will evaluate you based on your credit score, income, job status, and several other factors to make sure you’ll be able to pay back the loan.

Qualifying for a land loan is usually harder than qualifying for a standard mortgage. This is because land loans are riskier for lenders, as they don’t have the collateral of a home in case you don’t pay. There may be a higher minimum credit score requirement and you’ll need to explain what you intend to use the land for, among other requirements.

How Much Can I Borrow With A Land Loan?

The amount you can borrow, as well as your interest rate, will depend on your credit, the type of land being purchased, your down payment and the lender working on the loan. Tell potential lenders about the land you want to buy, including its location, price and what you want to do with it. This will help them accurately advise you on your eligibility for loan approval, including the maximum loan amount.

Types Of Land Loans

As previously mentioned, land loans come in many shapes and sizes, just like different lots of land. Let’s take a look at a few common types of land loans so you can think about which one might apply to your land buying goals.

Raw Land Loan

In real estate, raw land is a term used to describe plots of lands that have no utilities like roads, sewers or electricity. Due to the lack of these resources, raw land can be risky to develop. This means lenders will be stricter on preapproval requirements.

To combat skeptical lenders, create a well thought out and detailed plan for how you want to develop the raw land you are thinking of purchasing. This might put them at ease and help with loan approval.

Other ways to strengthen your loan application is to consider a sizeable down payment and make sure you have a high credit score. Even if you are approved, keep in mind that raw land loans usually have a higher down payment and credit score requirement than loans for other types of land.

Unimproved Land Loan

Unimproved land is a term used to describe plots of land that aren’t quire raw, but not completely developed as well. Think of unimproved land as somewhere halfway between having no utilities and having all of them. For example, a parcel of unimproved land might have roads, but no electricity or gas quite yet.

Improved Land Loan

Improved land is pretty much ready to build on. It has access roads, water, electricity, and gas. Because it is ready to go, improved land is usually more expensive than raw or unimproved land. However, improved land will usually have lower credit score and down payment requirements because it poses less of a risk to lenders. Improved land will also come with a lower interest rate on the land loan you use to acquire it compared to raw and unimproved land.

The Pros And Cons Of Getting A Loan To Buy Land

With any real estate decision, there are pros and cons. This is true of buying land as well. Let’s weigh the pros and cons so you can make an educated, informed decision.

Pros

• Borrowers can build a house or business on their property that meets their specific business or personal goals. From dream homes to profitable businesses, land loans can help people build a better future.
• Government programs like USDA loans can provide land loans at low interest rates with a minimal down payment.
• In some areas, buying land and building might be more affordable than purchasing a previously owned house.

Cons

• Land loans are riskier than home loans since a house isn’t being used as collateral. This means lenders often need to mitigate that risk with higher interest rates, higher down payment minimums and stricter loan approval requirements.
• Not all lenders offer land loans.
• Some people chose to use their primary residence as equity to secure a land loan. If you do this, you risk losing your home if you can’t make the payments on your land loan.
• The process can be cumbersome, with tasks like surveying and zoning reviews needed for a land loan that you don't need to worry about with a traditional mortgage.

Look at each benefit and drawback and decide which ones are most important to you. If selecting the exact layout and finishes for your home is important to you, buying land and building a new home might be the way to go. If you need to move in somewhere fast, then not so much.

Review each point carefully, do as much research as you can, and if the pros outweigh the cons, a land loan might be right for you. If not, you might want to stick to perusing current house listings to find your next home.

The Bottom Line: Consider If A Loan To Purchase Land Is Right For You

Many home seekers see purchasing land as a way to create a blank canvas that allows them to paint a perfect picture of their new home. The control of specific house details as well as the location can be comforting. Others prefer more established neighborhoods and the convenience of moving in quickly to a home that’s already built.

Before you start researching loans, think about which of these options appeals to you. It’s going to be easier to shop for homes and loans if you know what you’re looking for. That said, if you are split on whether to build new or buy a preowned house you can research both traditional mortgages and land loans to keep all your options open. It’s all about personal preference and how you envision your future in your new home.

Many people shopping for homes online focus on the interior. Things like kitchen counter finishes, bedroom size and inviting living rooms stand out when searching for homes online. Don't forget about the location and outside features while you’re home hunting. Maybe you like the idea of a secluded, wooded lot. Or perhaps you prefer a subdivision with lots of land around a cozy cul-de-sac.

It’s all about finding that dream location. When you find that perfect spot, a land loan can help you turn that dream into a reality. Hopefully you feel a little more informed about land loans and the role they play in buying land to build a house. Keep researching and learning to ensure you find the perfect place for your next abode.