October 23, 20237-minute read
Author: Emma Tomsich
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*As of July 6, 2020, Rocket Mortgage® is no longer accepting USDA loan applications. Sometimes when potential home buyers are looking to buy a house, they start to consider building one instead.Before going down this road, borrowers should determine what it might cost to build a house and buy the land to build it on. Though building a house can be expensive, there are many ways to make it more feasible for first-time homeowners. Land loans are one of these resources. If you choose to build a house, chances are you’ll apply for a land loan. While Rocket Mortgage® doesn’t offer land loans or lot loans, we understand the importance of providing real estate insight and know-how, and we can help point you in the right direction to find the right lot for your new home.
What Is A Land Loan?
A land loan – sometimes referred to as a lot loan – is used to finance the purchase of a plot of land. You can take out a land loan if you’re interested in buying a piece of land to build a home or use for business purposes. The type of loan you take out will depend on where you’re buying land and how you intend to use the land. A land loan is sometimes confused with a construction loan, which is another type of loan often used by people looking to build a house. So, what’s the difference? Typically, if you want to buy land and start building on it right away, you get a construction loan. These short-term loans are intended for prospective home builders who want to start on their construction project right away and have everything planned and ready to go. Land or lot loans, on the other hand, are a better choice for future home builders who have a plan but may not want to jump right into building and financing a house. If you have circ*mstances pushing your building project out a year or so (or you’re still getting your home plans together) a land loan is likely a better choice for you. While Rocket Mortgage doesn’t offer land or construction loans, you can still qualify for a mortgage on a new-construction house. We can also help you refinance an existing construction loan into a traditional mortgage onceyour new home is built. The home must be finished and have a Certificate of Occupancy.
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Types Of Land Loans
The three most common land loans are raw land loans, unimproved land loans and improved land loans. Raw land refers to a completely undeveloped area with no electricity, sewers or roads. Because it can be hard to get financing for undeveloped land, it’s important that you create a solid, detailed plan for how you want to develop the land. This will show lenders that you’re committed to the project and don’t pose a great risk. You can also increase your chances of qualifying if you make a large down payment (typically 20% or more) and have good credit. While the purchase price of raw land can be cheaper than developed land, raw land loans have higher interest rates and require larger down payments than other land loans. Unimproved land is similar to raw land, but it tends to be more developed. Sometimes unimproved land has some utilities and amenities, but it typically lacks an electric meter, phone box and natural gas meter. While an unimproved land loan isn’t as risky as a raw land loan, it can be difficult to get. To improve your chances,make sure you have a detailed plan, a large down payment (20% down or more) and a strong credit score. Because unimproved land loans aren’t the riskiest loan type, the down payment requirements and interest rates won’t be sky-high, but it’s common for them to be higher than other types of loan financing. Unlike raw land and unimproved land, improved land has access to things like roads, electricity and water. Improved land is the most developed type of land, so it may be more expensive to purchase. However, the interest rates and down payments for improved land loans are lower than raw land loans or unimproved land loans. Nonetheless, you still need to make a significant down payment and have a good credit score.Raw Land Loan
Unimproved Land Loan
Improved Land Loan
How Do Land Loans Work?
A borrower obtains a land or lot loan the same way a home buyer obtains a mortgage loan. However, it can be harder to determine what the land is worth because there is no property collateral. This means that land loans are a riskier transaction for lenders, which results in higher down payments and interest rates than a typical home loan. Let’s explore how to buy land to build a house. Each land loan type has qualifications borrowers must meet. However, there are still general requirements borrowers must meet to apply for a land loan: Once a lender considers these factors, the rates and obligations of the land loan can be issued. Land loan interest rates tend to be higher than mortgage interest rates because they’re riskier. However, a borrower can qualify for lower rates if they have a better credit score and a low debt-to-income ratio (DTI). After the loan’s rates are determined and the borrower is approved, the borrower must make a down payment and paythe loan back in installments for the determined interest rate.Loan Qualifications
Lending Process
Once the construction of your new house is complete, you can refinance your land loan into a traditional mortgage. Refinancing can help you secure a new principal balance and lower interest rate. To refinance to a traditional loan with Rocket Mortgage, construction must be fully completed and you must have a Certificate of Occupancy.
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Browse lots for sale near you on Rocket Homes.
Pros And Cons Of Land And Lot Loans
If you’ve considered applying for a land loan, you’ve likely realized that there are some benefits and drawbacks. To help make your decision easier, let’s go over some pros and cons and see how they’d apply to your needs and financial situation. If building a home or business is important to you, applying for a land loan offers many benefits. The biggest benefit by far is the opportunity to build the home of your dreams. If you want to use the land for commercial purposes, it offers businesses the opportunity to capitalize on up-and-coming areas. If you have a vision and are creative and patient, using a land loan to build a home or business can be the perfect option for you. It’s important to understand the realities and drawbacks of applying for a land loan. For example, when there isn’t a house to use as collateral, a land loan can be riskier for lenders, which makes many lenders less willing to lend money. When it comes to financing, there is also the potential for a higher down payment requirement and higher interest rates. Because it’s a new construction, there’s always the possibility of dealing with unforeseen complications, for example building supply shortages. For some buyers, a traditional mortgage may be a better option that offers a smoother buying experience.Pros
Cons
How To Get A Land Loan
It’s typically easiest to get a land loan from a community bank or credit union located near the land you’re looking to buy. But depending on your intention for the land, there may be other loan options available. If you’re planning to build a primary residence in a rural area, you can apply for a U.S. Department of Agriculture (USDA) loan. USDA loans and USDA construction loans are intended for low- to moderate-income families. They have low interest rates, and depending on the situation, borrowers may qualify for a lot loan with no down payment. If you’d like to use a land loan for commercial purposes, you can apply for an SBA 504 loan. SBA loans are provided by the Small Business Administration (SBA) and are intended for business owners who need funds to purchase land. The interest rates and terms of SBA loans can vary, but the repayment period typically lasts 10 – 25 yearsPrimary Residences
Commercial Properties
Other Land Purchasing Options
If you’re interested in purchasing land but are wary of taking out a land loan, consider these other options that may be more suitable for your needs. Home equity loans act as a second mortgage and allow you to use some of the equity you’ve built in your existing home. A home equity loan doesn't require a down payment, and you can usually lock in a lower interest rate regardless of your plans for the land because your home secures the loan. In addition, the interest you pay isn’t tax-deductible because you’re not using the loan to buy, build or improve the home used as collateral. The loan repayment term can vary depending on the lender but can last 5 – 30 years. Unfortunately, if you default on the loan, you may lose your primary home. Rocket Mortgage is now offering The Home Equity Loan, which is available for primary and secondary homes. Seller financing can be a desirable option for some borrowers. Seller-financed land agreements are sometimes called land contracts. They are real estate agreements where the seller acts as a lender and directly handles the mortgage process. Instead of applying for a traditional mortgage, a buyer signs a contract with a seller. This option can be beneficial for buyers because sellers tend to be more flexible than financial institutions, which means it may be easier to qualify for a seller-financed loan than a traditional loan. Seller financing can be useful for aspiring land buyers who are struggling to qualify for a land loan or afford a large down payment. However, legal homeownership can be a bit of a gray area when paying for a seller-financed property. While you receive an equitable title, your seller retains the legal title of the property until you pay off the loan, which can cause problems. Additionally, your seller may charge you higher interest rates and the terms of your contract may be vague.Home Equity Loan
Seller Financing
The Bottom Line
If you’d like to build a home, be sure to weigh the benefits and drawbacks of a land loan to see if it’s right for you. While the thought of building your dream home may sound perfect, there are other options available. Rocket Mortgage doesn’t offer land loans, we may be able to help you refinance an existing land or construction loan to a traditional mortgage on your newly built house. Get preapproved for a mortgage today to get started. If you want to design from the ground up, a land loan may be the best choice for you. You can get started by exploring open lots in your area to find the perfect spot to build.
Looking for the right place to build?
Find the perfect plot for your new house on Rocket Homes.
I've spent years delving into real estate financing, encompassing everything from traditional mortgages to specialized loans like land and construction financing. The article you mentioned is a comprehensive guide to land loans, covering their types, qualifications, advantages, and potential drawbacks.
In essence, a land loan or lot loan serves to finance the purchase of land for building a home or utilizing it for business purposes. It's distinct from a construction loan, which is obtained when there's an immediate intention to build on the acquired land. The article distinguishes three main categories of land loans: raw land loans, unimproved land loans, and improved land loans. Each has varying degrees of development and associated risks for lenders and borrowers.
To delve deeper, raw land loans are the riskiest due to the lack of development, necessitating solid plans and often substantial down payments. Unimproved land loans sit in the middle in terms of risk, offering a bit more development but still requiring meticulous planning and relatively larger down payments. Improved land loans, with existing infrastructure like roads and utilities, tend to be less risky for lenders and consequently have lower down payment and interest rate requirements.
The article rightly points out the complexities of assessing land value since there's no physical property to serve as collateral. Hence, lenders tend to impose higher down payments and interest rates due to the riskier nature of these loans. Borrowers typically need excellent credit scores, detailed plans for land usage, and thorough property evaluations to qualify.
Moreover, it's not just about understanding land loans but also considering alternatives like USDA loans for primary residences in rural areas or SBA loans for commercial purposes. Home equity loans and seller financing are additional options, each with their own sets of advantages and risks.
Overall, the article does a commendable job outlining the intricacies of land loans, shedding light on their advantages (like building one's dream home or capitalizing on business opportunities) and potential pitfalls (higher down payment requirements, higher interest rates, and unforeseen complications in construction). It encourages readers to evaluate their needs and financial situations before deciding on a land loan.
If you're looking for specific advice or further clarification on any aspect, I'd be happy to dive deeper into this topic!
