You’ll probably need a land loan if you want to buy that piece of land up in the mountains and create the perfect family cabin or retirement house one day.
There are a few differences between land loans and mortgages to be aware of if this is an option you’re considering. For one thing, these loans aren’t as common as standard home loans, and “…the financial tools for buying property and then the building has always been a lot less convenient than getting a typical mortgage,” says Alec Hartman, CEO of Welcome Homes, an online residential real estate platform.
Because financing the acquisition of land is riskier for the lender, don’t expect the same cheap mortgage rates that have been making news. Land loans involve higher interest rates, larger down payments, and shorter payback duration than other types of loans.
You can borrow money to buy land using a land loan, but it won’t cover the cost of building a home. To do so, you’d need to take out a second loan when you’re ready to start construction. Alternatively, you can forego the land loan entirely and use a construction loan to pay for both the land and the structure at the same time. So, before you forward with a land purchase, think about why you want the land and whether or not a land loan is the best option for you.
When potential home buyers are looking to buy a house, they may also think about building one. The idea may sound ideal until future homeowners consider how much a house may cost to construct. Though building a home might be costly, there are several ways to make it more affordable for first-time buyers. One of these resources is land loans.
What Is A Land Loan?
A land loan, also known as a lot loan, is used to finance the acquisition of a piece of property. If you want to acquire a piece of land to build a house on or use for business purposes, you can get a land loan. The type of loan you get will be determined by where you’re buying land and how you want to use it.
A land loan is frequently confused with a construction loan, which is a different sort of loan commonly utilized by those who want to build a home. So, what’s the difference between the two? If you want to buy land and start building right away, you’ll most likely need a construction loan. These short-term loans are designed for aspiring home builders who are ready to start working on their projects right away and have everything planned out.
Land or lot loans, on the other hand, are a preferable option for aspiring home builders who have a plan but don’t want to start building and financing a home right now. A land loan is likely a better option for you if you have conditions that will delay your construction project for a year or more (or if you’re still putting together your home designs).
Because there is less demand for land than there is for already-constructed homes, a vacant property is far more difficult to sell than a lot with a house on it. “Most people are incapable of purchasing property and constructing a structure on it,” adds Fleming. “It takes a lot longer and costs a lot more money than people imagine.”
People want something they can start with and improve on, even if it’s a fixer-upper.” While land loans are less common than other types of house finance, it’s still a good idea to shop around if you can to ensure you’re getting the best deal available.
How Do Land Loans Work?
Because there are various sorts of land loans, each one has its own set of requirements that borrowers must follow. When a borrower asks for a land or lot loan, however, some fundamental principles are taken into account. As with any loan, a borrower must demonstrate that they have a high credit score (720+).
They’ll also have to explain what they want to do with the land, which will differ depending on the type of loan they’re looking for. Borrowers must also call attention to characteristics of the property that need to be examined, such as zoning, land-use limitations, surveyed boundaries, and utility access. These characteristics will help lenders determine how dangerous a loan is.
The rates and obligations of a land loan can be granted once a lender takes these elements into account. Because land loans are riskier, their interest rates are typically higher than mortgage interest rates. A borrower with a higher credit score and a smaller debt-to-income ratio, on the other hand, maybe eligible for reduced rates.
When you apply for a land loan, the lender will also consider the block itself, in addition to these questions. The lender may consider the land’s size and location, as well as how accessible it is, the availability of infrastructures such as roads and utilities, and what you plan to do with it. If you want to build an owner-occupied home on the property, for example, a lender may view your application as less hazardous than if you intend to build an investment property on it or have no specific plans for it at all.
The borrower is responsible for making a down payment and repaying the loan with the calculated interest rate after the loan’s rates have been determined and the borrower has been approved by a lender and agreed to the loan’s terms.
Different Kinds of Land Loans
1. A loan for raw land
There is no electricity, sewers, or roads on this undeveloped site. This is the loan type for you if you’re interested in this type of land. Because funding for undeveloped land might be difficult, it’s critical to prepare a firm, thorough plan for how you wish to develop the site.
This will demonstrate to lenders that you’re serious about the project and don’t constitute a significant risk. If you put down a big down payment (usually 20% or more) and have strong credit, you’ll have a better chance of qualifying. While raw land can be less expensive than developed land, raw land loans have higher interest rates and require larger down payments than conventional land or lot loans.
2. Loan for Unimproved Land
Unimproved land is comparable to undeveloped terrain, however, it is more developed. Unimproved land may have certain utilities and facilities, but it usually does not have an electric meter, phone box, or natural gas meter. While an unimproved land loan is less risky than a raw land loan, it can still be tough to secure, so make sure you have a thorough plan, a big down payment (20 percent or more), and a good credit score before applying. Because unimproved land loans aren’t the riskiest sort of loan, down payments and interest rates aren’t as high as other types of loan financing, but they are popular.
3. A Better Land Loan
Improved land, unlike raw land and unimproved property, has access to roads, power, and water. Because improved land is the most developed, it may be more expensive to buy. An improved land loan, on the other hand, has lower interest rates and down payments than a raw land loan or an unimproved land loan. Despite this, a substantial down payment and a decent credit score are still required.
Land and lot loans are obtained in the same way that a buyer would obtain a mortgage loan, but because there is no property collateral, it can be more difficult to assess what the land is worth. As a result, land loans carry a larger risk for lenders, resulting in higher down payments and interest rates than a standard home loan. Your average land loan interest rate will most likely be between 4% and 5%, which is approximately double the average existing home loan interest rate.
Land Loans: 3 Things to Consider Before Purchasing Property
You’ll almost certainly require a land loan if you buy land rather than an existing house since you wish to start from scratch. And that creates more issues than just acquiring a regular mortgage. For starters, there isn’t a home to provide as collateral for the land loan. Obtaining land financing presents a unique set of challenges for prospective buyers. Here are three things to think about when purchasing a property.
1. Basic Land Concepts: Boundaries, Zoning, and Access
First and foremost, it is critical to understand the scope of the proposed transaction. This is why having surveyors draw the borders and having everything on paper ready to deliver to the lender is critical. Double-checking zoning and land-use regulations is another crucial aspect. Access to utilities is a major consideration for residential sites. Water, sewer, electricity, and cable hook-ups are all ready to go, which saves time, money, and aggravation.
Similarly, public road access might be a major concern, since the buyer will need to obtain a permanent easement to use a public road if one is not already in place. It’s also a good idea to check with the local planning authority to see what the future holds for the area. A new park down the street has the potential to increase property prices in the coming years, whereas a new highway or sewage treatment facility is less likely to do so.
2. Land Use Planning: Build Now, Make Improvements Later, Invest Speculatively
The loan terms, such as down payment and interest rate, are usually determined by the land’s intended use, which is directly tied to the bank’s risk exposure. In this regard, obtaining a land loan is usually more difficult than obtaining a mortgage for an existing home, because an existing home provides the bank with instant, tangible collateral, whereas new construction has more moving elements that can go wrong.
Buying a build-ready land to immediately start construction of a primary dwelling is the next step down the bank’s confidence ladder from existing homes. Things could go wrong, cause delays, or boost costs along the road, but the bank believes the schedule is still reasonable. The needed down payment will usually be between 15% and 25% of the total purchase price.
Finally, there is undeveloped land with no plans to develop it, which is essentially a speculative investment. A project in this manner, for example, could entail purchasing land in preparation for the development of a new motorway nearby. When the motorway is finished, the expectation is that the site will be appealing to developers looking to establish a new community with a quick commute into the city. The land might subsequently be sold for a profit to the developer. A down payment of up to 50% may be required for these loans.
3. Land Loan Alternatives: Obtaining Funding
Given the aforementioned issues, you may need to look into other options for financing your land acquisition. Consider the following resources:
Financing from the seller
This is a fantastic way to negotiate good terms, especially if the seller is desperate to sell the land and the market is slow. Everything, from the down payment to the interest rate, is negotiable because this is an agreement between two private persons. Before signing anything, have the papers reviewed by an attorney to avoid any loopholes or unpleasant surprises for either party.
Local Credit Unions and Banks
Local banks and credit unions are more likely to approve land loans than big banks. Due to their local understanding of the property, they may also be able to provide better terms. Regardless, a potential borrower must offer a loan package that includes land specifications and blueprints, as well as personal financial details to demonstrate creditworthiness.
US Department of Agriculture Loan
How can people acquire land if banks and credit unions refuse to lend them money? The buyer may be eligible for federal assistance if the property is rural and agricultural. The United States Department of Agriculture (USDA) offers a variety of low-interest subsidized loans with flexible terms.
Loan Against Your Home
A home equity loan might be a good option for a buyer who already owns a home and has low debt. This form of financing uses the existing property’s equity to provide substantially better terms than a traditional construction or land loan.
Top 7 Land Loan Facts You Should Be Aware Of
For borrowers in the Loan / Mortgage segment, land loan or plot loan (both terms are interchangeable) is one of the most perplexing topics. The distinctions between a home loan, a land loan, and a composite loan are frequently misunderstood.
Each of the three products has its own set of features, perks, and terms & conditions. Unfortunately, all three types of loans, namely, home loans, land loans, and composite loans, are referred to as “home loans” solely. Land Loans are only approved at the macro level for the purchase of a residential plot or piece of land.
The term “Composite Loan” refers to a loan that combines a land loan with a construction loan to finish the plot’s building. My consumers are frequently unaware of whether they have taken out a Land Loan or a Composite Loan. A land loan can only be used to buy a non-agricultural plot or piece of land that is within the limits of the Municipal or Local Development Authorities.
HDFC offers land loans for residential properties outside of municipal borders, but only under particular circumstances. Composite loans are a completely different concept, which I will cover in my future piece. This article will cover some of the most crucial facts about Land loans. To avoid any future surprises, you should be aware of these facts as a borrower.
1. Commencement of Construction: As far as I can tell, the “Construction” clause/condition linked to the Land Loan is what causes the confusion between composite and land loans. All Land Loans come with the requirement that building on the land/plot begins within a certain time frame.
Just to be clear, the cost of construction is included in the loan value in a composite loan. In the case of a land loan, however, it is just a prerequisite for the loan to be approved. A land loan borrower may then take out a construction loan to finish the work on the site.
The caveat is that if you are purchasing land at a high price, the loan provider may approve a composite loan under the Land Loan umbrella to raise your loan eligibility. The borrower is unaware that the loan includes building costs. He will be unable to obtain building financing in the future and will have no choice but to sell the land.
If you are not planning to build shortly, an HDFC Land / Plot Loan is a good option. The reason for this is that among all loan sources, HDFC offers the longest grace time to begin building. The borrower must begin construction on the land/plot within 5 years of receiving the first disbursement under the HDFC Plot Loan.
With other lenders, such as SBI, this term is usually two years. If you’re looking to buy a parcel of land as an investment, HDFC is the greatest option because you can sell it in 5 years and make a return. When contrasted to flats, land usually appreciates faster.
2. Penalty for Non-Completion of Construction: Land / Plot Loans are typically not approved by lenders. The reason for this is because the land is a non-revenue generating asset, and a lender’s primary concern is how the borrower will pay the EMI. Second, land acquisition is largely speculative. To address these concerns, all Land / Plot Loans have a start provision. Now you’re probably asking what happens if I don’t start building inside the specified time frame.
3. Income Tax Benefits on Land Loans: One of the most common misconceptions is that because a land loan is a home loan, it is eligible for the same tax benefits as a home loan. Please note that because a loan on a plot of land does not qualify as a home loan, INCOME TAX benefits are not accessible. Even if you finish building on the plot/land, you will be eligible for a Home Loan. Any interest paid before the completion of the construction project cannot be claimed as Pre-EMI interest, as it can be with a home loan. Ironically, I had to put this topic under the Home Loan category because users will only look for Plot Loan posts under that area:).
4. LTV (Loan to Value Ratio): For home loans, the LTV (Loan to Value Ratio) is usually set at 80%. The LTV for a land/plot loan is usually between 60% and 70%. Some lenders claim to fund 80% of the property value, however, this is based on the market value determined independently by them. For instance, you are purchasing land for 40 lakh, but the loan lender believes the market worth is only 30 lakh. In this situation, the loan provider will grant a land loan for 80 percent of the total amount of 30 lakh, or 24 lakh. 60 percent of the real consideration value will be 24 lakh.
5. Higher EMIs / Shorter Loan Terms: If you borrow X amount for a home loan and the same amount for a land loan, the EMI for the land loan will be higher. The reason for this is that pure land/plot loans are only granted for a short period. It also depends on the borrower’s age, repayment capabilities, and other factors. Because land/plot loans are typically approved for 5–10 years, the EMI is high. The interest rate is usually the same as the interest rate on a home loan.
6. Prepayment Penalties: Because a land loan is not considered a home loan, the lender may levy a prepayment penalty. It is usually a good idea to clarify this when applying for a Plot Loan. According to the websites of loan providers, borrowers labeled as “other than individual” are usually penalized. I’m not sure how they’ll differentiate between person and non-individual. They appear to be referring to non-salaried people, such as self-employed people, as “other than the individual.”
7. Legal Compliance: When compared to flat, the legal compliance of land or plot is more complicated. There are complications, such as converting from agricultural to residential use or dealing with legal successors. Second, because most states’ land records aren’t digitized, it’s a good idea to double-check legal compliance before purchasing or applying for a land loan. When compared to a home loan, the likelihood of loan refusal is higher for a land loan. You can buy a constructed property from a builder, especially in a gated community, to be on the safe side. A planned plot makes it easier to obtain a loan. Second, some developers specialize in tracts of land. They may not be as well-known as builders who work in the construction industry. For a developed site, you can find such builders in your city.
It’s always a good idea to be a cautious investor. To avoid future surprises, double-check all data before applying for a land loan. Almost 90% of borrowers do not read the loan agreement, although it is always a good idea to review the terms and conditions. I agree that the language used is complex, but you can always get legal advice. When I mentioned this to one of my clients recently, she told me that if she read the land loan agreement, she might not be able to get the loan. To some extent, I agree with her. “Ignorance is bliss” for her, but it could cost her dearly in the future.
How to Select a Land Site
Lenders prefer to support initiatives that are less risky, less expensive, and simpler. You might be able to get a land loan if you have the following factors:
1. Boundaries and surveying
A survey is necessary to avoid any future legal issues and to provide a clear image of exactly what land will be yours. Before you buy the land, you should survey to ensure that you are aware of its borders. Before approving a land loan, most lenders will require a thorough American Land Title Association (ALTA) boundary survey.
2. Services and utilities
Check for amenities such as sewage, paved roads, power, and water on the property. While most land will have access to these items, if you don’t have any or are buying raw land, make sure you have or can get the budget, appropriate licenses, and land space, as well as follow all state and local rules and health codes.
3. Restrictions and other FLUFF STUFF
Depending on your intentions for your site, you’ll need to make sure the zoning permits you to finish your project lawfully. If you’re looking to acquire land to build a house, make sure it’s zoned for residential use. Also, learn about any other special rules that apply to your land, as well as what you may and cannot do.
4. Environment and wildlife
Make sure you’re not planning to build on land that is protected by the US Fish and Wildlife Service because of endangered plant or wildlife species. Furthermore, states frequently have longer lists of endangered plants and animals. This may, however, be good news because you may be eligible for government incentives to assist safeguard endangered species, create less harm, and support the environment while building. Finally, you should be aware of any environmental risks so that you can make appropriate plans.
5. Changes in the future
Are there any development projects near your property, such as a new roadway, school, or shopping complex, in the works? The value of your land may be affected by the construction of new facilities, so make sure to factor such factors and research into your planning to guarantee that your land continues to satisfy your demands.
How do you know what to look for in a land loan?
When considering land loans, bear in mind the interest rate, any fees that may apply, the size of the deposit necessary, and your plans and intentions for the land.
1. Rates of interest
Because lenders consider land loans to be riskier than other forms of home loans, interest rates on them might be higher, resulting in you paying more over the life of the loan. When evaluating loans, it’s important to think about which lenders could be able to provide you with the best interest rates.
Similarly, given the risk associated with land loans, certain lenders may charge greater costs, so this is another element to consider when comparing. The comparative rate is an estimate of a loan’s total cost over a year, including fees as well as interest, which lenders are required to provide to you along with the loan’s interest rate.
3. Make a deposit
The lower the loan’s LVR, the bigger the deposit you’ll have to put down. If a lender offers you a high LVR for a land loan, you may be able to pay less of a deposit, but keep in mind the loan’s comparative rate and how much you’ll pay in total when interest, fees, and charges are taken into account.
Alternative Land Purchases
If you’re thinking about buying land but are hesitant to take out a land loan, explore these other choices that might be a better fit for your circumstances.
1. Home Equity Loan
Home equity loans are different from land loans, and for some borrowers, they may be a better option. They don’t require a down payment, and because your home secures the loan, they can usually lock in a lower interest rate regardless of what you plan to do with the land. Furthermore, because you are not using the loan to buy, build, or enhance the home used as security, the interest you pay is not tax-deductible. Depending on the lender, the loan repayment period can range from 5 to 30 years.
2. Financing from the seller
For some borrowers, seller financing may be a viable choice. Land contracts are a term used to describe seller-financed land transactions. These are real estate agreements in which the seller, rather than a financial institution or lender, acts as a lender and manages the mortgage process directly.
The buyer signs a mortgage from the seller rather than applying for a standard mortgage. This method may be advantageous to purchasers since sellers are more flexible than financial institutions, making a seller-financed loan easier to qualify for than a typical loan.
Seller financing can be beneficial for ambitious land buyers who may be unable to qualify for a land loan or afford a big down payment, but it also has drawbacks. When paying for a seller-financed property, legal homeownership can be a bit of a gray area since, while you will receive an equitable title, your seller will retain legal title until you pay it off, which might present issues. Furthermore, your vendor may charge you higher interest rates, and your contract’s conditions may be imprecise.