Land Loan Explained
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.
Recommended Land Loan Lending Partners
Land Loans Versus Mortgages, What’s the Difference?
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.
How to Apply for a Land Loan?
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:
- Tax returns
- Collateral information
- Documents describing the land, such as a parcel ID number, appraisal, or map of the property
- Credit score
- Balance sheets
- Land loan plan
- Assets and debts verification
Types of Land Loans
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!
Raw Land Loans
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.
Vacant Land Loans
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.
USDA Land Loans
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.
SBA 504 Loan
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.
A 5‐year $10,000 loan with 9.99% APR has 60 scheduled monthly payments of $201.81 to a total amount of $12,108.6.
A 3‐year $5,000 loan with 5.99% APR has 36 scheduled monthly payments of $150.57 to a total amount of $5,420.52.
Good terms to know
- Collateral: This is an asset that a lender can seize in case a borrower defaults on their loan. Collateral may be sold to recoup some or all of the losses on the loan.
- Loan-to-value ratio (LTV): This term is used by lenders to examine the ratio of a loan to the value of an asset, such as a piece of land, purchased.
- Interest rate: This is the amount charged by a lender on top of the amount borrowed.
- Annual Percentage Rate (APR): The total annual rate charged for borrowing from a lender.
- Credit score: A three digit number that represents how risky you are as a borrower based on your credit history.
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.
*Credible Personal Loans Rate and Terms Disclosure: Rates for personal loans provided by lenders on the Credible platform range between 5.40-35.99% APR with terms from 24 to 84 months. Rates presented include lender discounts for enrolling in autopay and loyalty programs, where applicable. Actual rates may be different from the rates advertised and/or shown and will be based on the lender’s eligibility criteria, which include factors such as credit score, loan amount, loan term, credit usage and history, and vary based on loan purpose. The lowest rates available typically require excellent credit, and for some lenders, may be reserved for specific loan purposes and/or shorter loan terms. The origination fee charged by the lenders on our platform ranges from 0% to 8%. Each lender has their own qualification criteria with respect to their autopay and loyalty discounts (e.g., some lenders require the borrower to elect autopay prior to loan funding in order to qualify for the autopay discount). All rates are determined by the lender and must be agreed upon between the borrower and the borrower’s chosen lender. For a loan of $10,000 with a three year repayment period, an interest rate of 7.99%, a $350 origination fee and an APR of 11.51%, the borrower will receive $9,650 at the time of loan funding and will make 36 monthly payments of $313.32. Assuming all on-time payments, and full performance of all terms and conditions of the loan contract and any discount programs enrolled in included in the APR/interest rate throughout the life of the loan, the borrower will pay a total of $11,279.43. As of March 12, 2019, none of the lenders on our platform require a down payment nor do they charge any prepayment penalties.