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Purchasing vacant land can be an exciting prospect, but will often require a land loan. Land loans are a financing option used to buy a plot of land and, like a mortgage, can be obtained through a bank or a lender, who will evaluate your credit history and the land value to determine if you’re an eligible buyer.
However, land loans are risky for lenders, since there is no home to act as collateral. That’s why it’s important to be prepared for a higher down payment and interest rate to secure a loan to buy land.
How to get a land loan
The process of getting a land loan is similar to view it that of getting a traditional mortgage. As discussed later, the different types of land loans have varying qualifications, though you’ll generally need excellent credit, an acceptable debt-to-income (DTI) ratio of roughly 30% to 40% and consistent income.
The reason for the strict qualifications? Compared to constructed property, land tends to be a riskier investment. Land loans are often short-term, two- to five-year loans followed by a balloon payment , compared to the typical 15- and 30-year terms offered on a home mortgage . There are longer terms available in special cases, particularly if you are going to use the land to build a home.
Different types of land loans
Depending on where you buy land and for what purpose, the process and options for getting a loan could vary. Below we explain the common land loan types and how to buy land.
Raw land loan
Raw land is land that isn’t cultivated and has no improvements, such as a home or other constructed elements. Buying raw land is often appealing since it’s cheap land and provides the flexibility to do what you’d like with it in accordance with local laws. On the other hand, raw land can be risky for lenders since it will likely take longer to develop. Having a solid development plan, excellent credit and a substantial down payment – sometimes up to 50% – may all make it easier to get a loan for raw land.
Lot land loan
Lot land, unlike raw land, has some infrastructure, such as electricity and water, already in place and is usually zoned for residential construction in developed areas. A benefit of lot land over raw land is that lenders tend to be more comfortable offering lot loans, as upfront costs are often lower. However, you’ll still need a 10% to 20% down payment, and terms can stretch up to 20 years.
Construction loans
A construction loan is a loan intended to help fund construction costs. Unlike a standard mortgage, a construction loan term lasts only as long as the construction process itself, before converting into a standard 15- or 30-year mortgage. Once approved, the lender will pay the construction team at each phase of construction.
Since there are many variables and more risk for lenders when constructing a home, construction loans typically require a minimum 680 credit score or higher, a 20% down payment and extremely detailed project plans that include an estimated schedule and budget. Although it may seem daunting, a high credit score, low DTI ratio, stable income and good location can all help you secure a more competitive rate on your construction loan.
Land loan interest rates
Since land loans are often risky to lenders, land loan rates tend to be higher than home loan interest rates . You are more likely to qualify for lower rates with a higher credit score and lower DTI ratio.