Buying land to build a house? What you need to know about home loans
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Most home buyers look at existing homes for sale and buy one they like. But some buyers prefer to buy land and build their dream home on it. If this interests you, you may need a home loan to make it happen.
If you’re not sure what home loans are or if you should get one, this guide will cover what you need to know so you can decide if this option is right for you.
What are home loans?
The mortgage, also called land loan or land loan, is used to finance the purchase of land. Banks usually give these loans to borrowers who want to build a house or use the land for business purposes.
The type of loan you need depends on the type of land you are buying. You have the choice between three types of home loans:
- Gross land loan — The raw land is completely undeveloped with no utilities or roads. Greenfield land is generally less expensive than other types of home loans, but getting financing can be difficult.
- Unimproved land loan — Unimproved lots may be partially landscaped and have utilities or older structures, but typically do not have electric or gas meters or a phone booth. It may be easier to get financing for unimproved land than raw land, but you’ll likely need a large down payment and a good credit score.
- Subsidized land loan — Improved land has access to roads and is fully functional. Because it is the most ready to build, it is also the most expensive and the easiest to finance.
How do home loans work?
If you have enough money in your savings account, you may be able to buy the land you want with cash. Otherwise, you can apply for a home loan.
The different financing options to help you buy land each have their own qualification criteria. But certain guidelines apply across the board: you’ll generally need excellent credit and a down payment of 15% to 35% of the purchase price or more.
The Federal Deposit Insurance Corporation (FDIC) sets minimum down payment requirements for home loans, although some lenders may opt for higher down payments (up to 50%). The FDIC deposit requirements are as follows:
- Earthen – 35% minimum deposit
- Undeveloped land — 25% minimum deposit
- Improved terrain — 15% minimum deposit
Because it can be expensive and complicated to develop land, lenders charge higher interest rates on home loans than traditional mortgages to mitigate their risk. Home loan repayment terms can be much shorter than standard conventional 15- and 30-year mortgages, as lenders seek to recoup their investment faster than with conventional home loans. But if you plan to build a house on the property, you may be able to secure a longer-term loan.
Although the terms and interest rates for land loans are different from those for mortgages, the loan process is similar. You will need to provide financial documents, such as pay stubs and bank statements, and the lender will review your credit report. As part of its underwriting process, the lender may ask you to provide information about how you intend to use the land.
Like a mortgage, if you are approved for a home loan, you will be obligated to pay off the balance with interest. But unlike mortgages, many home loans are often set up as “balloon mortgages.” This means that you will make few or no monthly payments, or only pay interest for a fixed period, before making a large lump sum payment to pay off the loan in full.
If you’re having trouble finding a home loan that meets your needs, you can consider a personal loan to help finance your purchase. Credible lets you compare personal loan rates from multiple lenders, all in one place.
How much loan can you get?
The amount you can borrow with a home loan varies depending on the lender and the type of land you are buying. For example, a lender may approve a loan that finances 85% of the purchase price of improved land or it may offer to finance 65% of the cost of greenfield land.
As with conventional mortgages, the amount you can get for a home loan depends on your income, debt-to-equity ratio, down payment amount, and other factors.
Mortgage financing options
When you’re ready to buy a property, you have many financing options, including:
Real estate loan lender
Few major national banks offer home loans, but many community banks and credit unions do. You can often get financing from a local lender in the same area as your land. Knowing the area, a local lender is in a better position to assess the land’s value and possibilities.
With seller financing, the seller offers you a loan rather than a bank or mortgage lender. You then submit your payment to the seller each month. The only amount you will have to pay at closing is the agreed amount for a deposit.
USDA Rural Housing Site Loan
USDA Rural Housing Site Loans provide financing to low- and middle-income families looking to build a home on land in an eligible rural area. USDA loans are often easier to obtain than conventional loans. These government guaranteed loans have a repayment term of two years.
SBA 504 loan
If you are buying land to use for a business, you may qualify for a 504 loan offered by the Small Business Administration (SBA). The 504 program provides long-term, fixed-rate loans of up to $5 million for projects that generate business growth and new jobs. Loans can be used for multiple purposes, including the purchase and construction of new facilities.
Home Equity Loan
If you already own a home and have significant equity, you may qualify for a home equity loan. In this case, you will receive a lump sum of money up front, which you will repay over time. It doesn’t matter what you do with the money, and you won’t have to pay a deposit. Plus, you can usually get a lower interest rate than a home loan. But if you default on the loan, you risk losing your home.
With Credible, you can easily compare personal loan rates from different lenders in minutes.
Advantages and disadvantages of mortgage
As with any financial decision, it’s always wise to think about the pros and cons. Consider these pros and cons to see if a home loan is right for you:
- You can build your dream home exactly the way you want. You also have the option of keeping the land and building only when you are ready.
- You can enjoy a booming neighborhood. Buy the land now for future construction in an area where property values are rising.
- You can use the land for commercial purposes. Establish a new location for your business.
- Obtaining financing can be difficult. Not all lenders offer home loans, and those that do often have strict loan requirements and high interest rates.
- You may need to pay more. Since home loans are not secured by collateral, many lenders compensate for the risk by requiring a large down payment and charging high interest rates.
- The land may not be ready to build. If you are buying raw or unimproved land, make sure you can get the utilities and improvements the land needs to support a home in the future.