Purchasing land can be an exciting and rewarding experience, whether you're looking to build your dream home, start a farm, or invest in property. Although it is easiest to buy land with cash, most people do not have enough cash on hand to purchase a property outright. The good news is that there are multiple financing options available. In this guide, we'll explore the options available for financing land purchases and provide tips on how to finance your own land purchase.
What is a Land Loan?
A land loan is a type of financing specifically designed for the purchase of raw, undeveloped land. Unlike a traditional mortgage loan which is used to finance the purchase of a home, a land loan is solely used for purchasing land. This includes both rural and urban properties, vacant or ready-to-build lots.
Land loans are typically more complex than standard mortgages. For example, there is no home to serve as collateral for a land loan, and you usually can not buy land with no money down (in fact, most lenders require anywhere from 20-50% of the purchase price for a down payment). This is because land loans are riskier for lenders than traditional mortgages- if the borrower defaults on the loan, it would be more difficult for the lender to recoup their money.
How do land loans work?
Land loans are typically short-term loans with terms ranging from 5-20 years. The interest rates for land loans can vary widely, typically falling between 5-15%. In addition to the down payment (which generally range from 20-50%), lenders may also require a higher credit score and proof of income and assets. Experian recommends that people who are seeing a land loan should have a credit score around the 700's at a minimum.
Once a land loan is obtained, the borrower must make their down payment and pay the loan back in installments (usually monthly) with the determined interest rate.
Types of Land Loans
When it comes to financing land purchases, there are a few different options available. The type of loan you choose will depend on your specific needs and the lender's requirements.
Raw Land Loans: This type of loan is for purchasing undeveloped, rural land without any existing structures. Raw land loans typically have higher interest rates and require a larger down payment compared to other types of loans. They are also the most difficult to obtain.
Unimproved Land Loans: Unimproved land is similar to raw land, but it is more developed than raw land. For example, unimproved land may have utilities and amenities, while raw land does not. Obtaining financing for unimproved land is generally difficult as well.
Improved Land Loans: Improved land has been developed with full utility and road access. Although improved land is generally more expensive than raw and unimproved land, it is the easiest to finance and generally has lower interest rates and down payments compared to raw and unimproved land loans.
Land Loan Sources
USDA: If you are planning to build a residence in a rural area, the USDA offers two loan options. Section 523 loans are designed for low-to-moderate income borrowers who plan to build their own home. Section 524 loans allow you to hire a contractor to build a home for you. Both have repayment terms of 2 years and can have low interest rates.
SBA 504 Loans: The SBA offers loans to purchase and develop land for commercial use. These loans have a low down payment requirement (typically 10%), fixed interest rates, and long repayment terms (up to 25 years).
Lender Loans: Traditional banks and credit unions also offer land loans. If you do not plan to develop the land, this option will likely require a larger down payment.
Home Equity Loans: Homeowners can also use their home equity to finance land purchases. This option typically has lower interest rates and no down payments, but it may have stricter requirements and could put your home at risk if you default on the loan.
Seller Financing: In some cases, the seller of the land may be willing to finance the purchase themselves. This often involves making a down payment and paying back the remaining balance over time with an agreed upon interest rate. If you choose to go this route, it is important to have any legal papers reviewed by an attorney.
Land Loans Pros and Cons
A land loan can be a good idea in many circumstances, but it is important to understand both the pros and cons of taking out a land loan before you make a decision. Land loans have long-term implications, so conducting due diligence is crucial.
Land Loan Pros
If the dream of building a home or a business is important to you, then considering the option of applying for a land loan can be a game-changer in reaching this goal. Land loans not only provide the necessary financial support but also come with a handful of advantages. These include more favorable terms compared to personal loans, such as lower interest rates and longer repayment terms, giving you the flexibility and peace of mind to develop the land exactly as you envision. With a land loan, you can embark on a journey of creating a property that truly reflects your desires and aspirations, ensuring a solid foundation for future growth and success.
Land Loan Cons
When it comes to interest rates and down payment requirements, land loans can often be more expensive compared to traditional home or construction loans. This is primarily due to the inherent risks associated with lending money for undeveloped land.
It's important to note that even if you are able to secure a land loan, there may be additional challenges that could hinder your plans for the land. These challenges may include issues with surveys, zoning regulations, and obtaining the necessary permits. Thus, it's crucial to thoroughly research and understand these potential obstacles before proceeding with a land loan application, as they can greatly impact your ability to fully utilize the land in the desired manner.
Tips for Financing Land Purchases
Research Lenders: Different lenders will have different requirements and offerings when it comes to land loans. Be sure to research multiple options to find the best fit for your needs.
Improve Your Credit: A higher credit score can help you secure a lower interest rate and better terms on your land loan. Take steps to improve your credit before applying for a loan.
Save for a Down Payment: As mentioned, most land loans require a significant down payment. Start saving early so you have enough funds for the down payment.
Get Pre-Approved: Before beginning your search for land, get pre-approved for a loan so you know how much you can afford and are prepared to make an offer when you find the right property.
Work with Professionals: Purchasing land can be complicated, so it is important to work with professionals, such as real estate agents.
Consider Where You are Purchasing Land: Some areas of the country have more affordable land for sale than others! If you are interested in purchasing land on a budget, there are many options available across the country, you may just need to expand your search.
It's worth mentioning that land loans typically have more stringent approval requirements, making them harder to obtain compared to other types of loans. Taking all these factors into consideration is crucial when deciding whether a land loan is the right option for you.
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