CARES Act Updates | December 2020
The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law by President Donald Trump in...
While nothing quite compares to buying a dream home, building one takes the dream to a whole new level. The first step forward in this exciting endeavor is to buy up the land your home will sit on, which can be a pricey venture, not to mention all of the costs involved in building your home. This is where a land loan comes into play.
A land loan is a loan specifically designed for those looking to buy a plot of land. Just like any other loan type, land financing can be done the traditional route—through a bank or credit union—or through the use of an online lender, which may offer more favorable land loan rates.
Unlike other loan types, especially a mortgage where there is a determined dollar amount assigned to the property, it’s a little trickier figuring out what exactly a piece of land is worth since there is no collateral. If a borrower were to default on their loan, they can much more easily walk away than if they default on their home or vehicle—assets that can be recouped by the lender. With nothing yet built on the land, there’s less skin in the game, so to speak.
Additionally, land isn’t as easy to sell if the borrower defaults since it isn’t in as much demand as houses. For these reasons, you can expect the interest rates and down payments for lot loans to be higher than other, less risky loan types.
While they seem similar, mortgages and land loans are two very distinct loan types.
One major distinction is the purpose of each loan. A mortgage is used to buy a home, plain and simple. A loan for land purchase, on the other hand, is used to buy the land a home will sit on. So those looking for land financing are most often doing so with the purpose of constructing a home on it. Some land loans will cover the costs of building the home, but most will only cover the costs involved in preparing the raw, unpolished land for construction.
Another big distinction between a mortgage and a loan to buy land is the value of the collateral. A piece of land is almost always worth less than that same piece of land with a home on it. Consequently, the collateral for a mortgage is worth much more than the collateral for a land loan. Because of this, plus the fact that it’s harder to determine the value of a plot of land, you have a lower loan amount, or in other words, a low loan-to-value ratio.
As mentioned earlier, loans to buy land are a riskier transaction than mortgages since they’re less valuable collateral. They’re also riskier for borrowers due to their low loan-to-value ratio. So for example, if you take out a land loan for $100,000 with the intention of developing a piece of land that’s worth $400,000, defaulting on the loan would mean losing out on $300,000 of value.
Mortgages, on the other hand, aren’t as risky in this sense because they’re typically at 80-90% loan to value. So in other words, a borrower will put down 10-20% and lose out on much less if they default.
The first thing to know about getting a loan for land purchase is that it’s not as easy to find as it is with a mortgage, since many lenders are wary about doling out risky loans. Mortgage brokers often have a wider net when it comes to finding a loan lender, or you could conduct the search yourself.
The type of lender you go with will depend on your plans. Are you going to build on the land or will you let it sit vacant and untouched for investment purposes or later use? If you plan on building on the land and are already working with a builder, it’s very likely that they’ll point you in the right direction to get a loan.
With that said, there are specialized land loan lenders you can apply with. Below are a few of the documents you’ll be needing when you apply:
There are several types of land loans to be aware of when searching for the best land loan lenders and before applying and comparing land loan rates. Let’s take a look!
This loan type is used for a piece of land that will not be developed or built upon. It’s the riskiest of all lot loans for lenders since there is nothing significant, such as a building or home, to use as collateral.
This type of loan is for a piece of land that will undergo some type of renovation or improvement so that they’re ready for construction. It’s for those who intend to build on top of the land.
If you intent to purchase land in a rural area for farming or other agricultural purposes, you may qualify for a USDA loan. This subsidized loan secures property that will build new farms, establish crops, enhance existing farming operations, or for alternative farming methods.
For businesses that intend to buy up land for commercial development, there exists a Small Business Administration (SBA) 504 Loan. With this type of loan, the SBA works with a lender to secure the property value so that the business owner will only have to supply 10% down payment. The rest is financed by SBA and lender.
This loan option is for those intending to construct on their land but don’t want to deal with taking out two loans. With a construction loan, the money will be used to finance not only the land itself but the construction work as well.
Purchasing a plot of land may feel like an unfamiliar and even daunting undertaking, but it can be a fairly straightforward process once you’re aware of what’s involved. If you have a clear plan for the land you plan on purchasing, the next step is to figure out which loan type fits your needs and begin taking a look at current land loan rates to find the best land loan lender.