Buying land allows you to build the home of your dreams or conserve a slice of nature. However, land can be expensive in high-demand areas, so you may need a loan to fund your land purchase. You might assume that land is a safe investment (after all, “they’re not making any more of it”), but lenders see land loans as risky, so the approval process can be more cumbersome than standard home loans.
The ease and cost of borrowing will depend on the type of property you’re buying:
- Land that you intend to build on in the near future
- Raw land that you don’t intend to develop
For the most part, land loans are relatively short term loans, lasting two to five years before a balloon payment is due. However, longer term loans exist (or you can convert to a longer term loan), especially if you’re building a residential home on the property.
Buy and Build in One Step
Lenders are most willing to lend when you’ve got plans to build on your property. Holding raw land is speculative. Building is also risky, but banks are more comfortable if you’re going to add value to the property (by adding a home, for example).
Construction loans: You might be able to use a single loan to buy the land and fund construction. This allows you to suffer through less paperwork and fewer closing costs. What’s more, you can secure funding for the entire project (including completion of the build) — you won’t be stuck holding land while you look for a lender.
Building plans: To get approved for a construction loan, you’ll need to present plans to your lender, who will want to see that an experienced builder is doing the work. Funds will be distributed over time, as the project progresses, so your contractors will need to follow through if they expect to get paid.
Loan features: Construction loans are short term loans, typically using interest-only payments and lasting less than one year (ideally the project is completed by then). After that time, the loan may be converted into a standard 30-year or 15-year loan, or you’ll refinance the loan using your newly-built structure as collateral.
Down payment: To borrow for the land and construction costs, you’ll need to make a down payment. Plan to come up with 10 to 20 percent of the future value of the home.
Finished Lots vs. Raw Land
If you’re buying a lot that already has utilities and street access, you’ll have an easier time getting approved.
Raw land: Raw land can still be financed, but lenders are more hesitant (unless that’s typical for your area — for example, some areas rely on propane, wells, and septic systems). It’s expensive to add things like sewer lines and electricity to your property, and there are numerous opportunities for unexpected expenses and delays.
Down payment: If you’re buying a lot (in a developing subdivision, for example), you might be able to put down as little as 10 or 20 percent. For raw land, plan on a minimum of 30 percent down, and you may have to bring 50 percent to the table to get approved.
Loan features: Finished lots are less risky for lenders, so they’re more likely to offer single-step construction loans that convert to “permanent” (or 30-year) mortgages after construction is completed. With unfinished lots, lenders tend to keep loan terms shorter (five to ten years, for example).
Reducing lender risk: If you’re buying raw land, you’re not necessarily going to get a bad loan. You can improve your chances of getting a good deal if you help the lender manage risk. It may be possible to get longer term loans, lower interest rates, and a smaller down payment requirement. Factors that help include:
- A high credit score (above 680), showing that you’ve successfully borrowed and repaid in the past.
- Low debt to income ratios, indicating that you have sufficient income to make required payments.
- A small loan amount, resulting in lower payments and a property that is most likely easier to sell.
No Plans to Develop
If you’re going to buy land without plans to build a home or business structure on the land, getting a loan will be more difficult. However, there are several options to get funding.
Local banks and credit unions: Start by inquiring with financial institutions located near the land you plan to buy. If you don’t already live in the area, your local lenders (and online lenders) may be hesitant to approve a loan for vacant land. Local institutions know the local market, and they may have an interest in facilitating sales in the area you’re looking at. Although local institutions may be willing to lend, they may still demand up to 50 percent in equity and relatively short term loans.
Home equity: If you have significant equity in your home, you may be able to borrow against that equity with a second mortgage. With that approach, you might be able to fund the entire cost of the land and avoid using additional loans. However, you’re taking a significant risk using your home as collateral — if you’re unable to make payments on the loan, your lender can take your home in foreclosure.
The good news is that interest rates on a home equity loan could be lower than rates on a land purchase loan.
Commercial lenders: Especially if you’ll use the property for business purposes or an investment, commercial lenders might be an option. To get approved, you’ll need to convince a loan officer that you’re a reasonable risk. Repayment may only last ten years or less, but payments might be calculated using a 15-year or 30-year amortization schedule. Commercial lenders might be more accommodating when it comes to collateral. They may allow you to make personal guarantees with your residence, or you might be able to use other assets (like investment holdings or equipment) as collateral.
Owner financing: If you can’t get a loan from a bank or credit union, the property’s current owner may be willing to finance the purchase. Especially with raw land, owners may know that it’s difficult for buyers to get financing from traditional lenders, and they might not be in a hurry to cash out. In those situations, owners typically get a relatively large down payment, but everything is negotiable. A 5- or 10-year repayment term is common, but the payments may be calculated using a longer amortization schedule. A benefit of owner financing is that you won’t pay the same closing costs you’d pay traditional lenders (but it’s still worth paying to research the title and boundaries — honest landowners can make mistakes).
Specialized lenders: If you’re just waiting for the right time to build or you’re picking a design for your house, you’ll probably have to use the solutions above. But if you have unusual plans for your property, there may be a lender that focuses on your intended use for the land. Unlike banks (working with people building houses, for the most part), specialized lenders make a point of understanding the risks and benefits of other reasons for land ownership. They’ll be more willing to work with you because they don’t have to figure out a one-off deal. These lenders may be regional or national, so search online for whatever you have in mind. For example:
- Conservation of natural resources
- Outdoor recreation on private property
- Solar or wind farms
- Cellular or broadcast towers
- Agriculture or livestock use, including ranching, organic farms, hobby farms, and horse boarding
Tips for Buyers
Do your homework before buying land. You might see the property as a blank slate full of potential, but you don’t want to get in over your head.
Closing costs: In addition to a purchase price, you may also have closing costs if you get a loan. Look for origination fees, processing fees, credit check costs, appraisal fees, and more. Find out how much you’ll pay, and make your final financing decision with those numbers in mind. For a relatively inexpensive property, closing costs can amount to a substantial percentage of the purchase price.
Get a survey: Don’t assume that current fence lines, markers, or “obvious” geographic features accurately show a property boundary. Get a professional to complete a boundary survey and verify before you buy. Current property owners may not know what they own, and it’ll be your problem after you buy.
Check the title: Especially if you’re borrowing informally (using your home equity or seller financing, for example), do what professional lenders do — a title search. Find out if there are any liens or other issues with the property before you hand over money.
Budget for other costs: Once you own the land, you may be on the hook for additional expenses. Review those expenses in addition to any loan payments you’ll make for the land. Potential costs include:
- Municipal or county taxes (check with your tax advisor to see if you qualify for a deduction)
- Insurance on vacant land or abandoned buildings
- Homeowners’ association (HOA) dues, if applicable
- Any upkeep required, such as repairing fence lines, managing drainage, etc.
- Building costs, if you ever decide to build, add services, or improve access to the property
- Permit fees, for any activity you have planned on the property
Know the Rules
When you see vacant land, you might assume anything is possible. However, local laws and zoning requirements limit what you can do — even on your own private property. HOA rules can be especially frustrating. Speak with local authorities, a real estate attorney, and neighbors (if possible) before you agree to buy.
If you discover any issues with a property you have your eye on, ask about making changes. You might be out of luck, or you might be able to do what you want after following the proper procedures (by filling out paperwork and paying fees). It will probably be easier if you ask for permission instead of upsetting your neighbors.