How to get a land loan: Everything you need to know

Land loans finance the purchase of an undeveloped plot of land, usually one you plan to build on or use to expand an existing property. But a loan to buy land is different than a mortgage used to buy a home. Even though Rocket Mortgage doesn’t offer land loans, we want to help aspiring homeowners learn about all their borrowing options. Here's how to get a land loan, how land loans work, and what to expect with requirements, rates, and alternatives.

Land loans vs. Conventional mortgages

A conventional loan is a mortgage specifically secured by an existing, livable residential structure. Because there is already a structure serving as tangible collateral, lenders generally view conventional mortgages as less risky than land loans.

If a lender forecloses on a home, it can sell the home to recoup its losses with relative ease. Undeveloped property is typically more challenging to sell.

To offset the increased risk, lenders often require a larger down payment, a stronger credit profile, and a shorter loan term for repayment.

However, if you have done your research and are financially prepared for the costs associated with building a house, a land loan might be the right financing option for you.

What is a land loan?

A land loan – sometimes called a lot loan – finances the purchase of a plot of land. When you buy an existing house, the structure serves as collateral. Because a vacant lot lacks a structure, land loans usually require a higher down payment and charge a higher interest rate.

Lenders will consider the appraised value of the land itself, as well as your income, assets, and creditworthiness. Appraising vacant land can be a challenge. There often isn't a recent sale of a comparable property to use as a base for its value in rural or newly developing areas.

If you’re buying land to build a house, a land loan can secure your preferred location even if you're not ready to hire an architect or pour a foundation. Once your loan is approved, you will make regular monthly payments with interest – much like you would with a traditional mortgage – until the land is fully paid off.

Construction loans vs. land loans

A construction loan finances building a new house. You can use a land loan to buy the land and a construction loan to build a home on it. A construction loan is specifically designed to cover the cost of building the home’s infrastructure, labor, and materials.

Construction loans operate differently from standard financing. They generally feature much shorter terms - often around 1 year - and the funds are not handed to you in a lump sum. Instead, they are paid out to your builder in staged installments, known as "draws," as your project reaches specific milestones such as pouring the foundation, framing the walls, or finishing the roof.

Once the physical construction of your property is complete and you receive a certificate of occupancy, many homeowners choose to refinance their short-term construction loan into a traditional mortgage. This simplifies your monthly payments and safely consolidates several documents during closing. That way, you aren't juggling multiple high-interest loans while moving into your new home.

Types of land loans

Three distinct types of land loans are available to prospective homebuilders: raw land, unimproved land, and improved land. Let's take a closer look at the main differences between them.

Raw land loan

Raw land loans are for undeveloped land with no access to electricity, sewers, or roads. Financing raw land is more challenging because it’s a riskier investment for the lender. Most lenders will require detailed plans for how and when development will be completed. You’ll typically need a down payment of at least 35% and good credit.

While raw land may be cheaper to buy than more developed land, you’ll typically get charged a higher interest rate on a land loan.

Unimproved land loan

Unimproved land is slightly more developed and may have access to some infrastructure, like water and electricity. However, utilities need to be installed, and there may be other improvements needed before it's livable.

Buyers who invest in unimproved land will need a clear picture of what has been done to the property and what hasn't before making an offer.

While lenders view this type of option as less risky than raw land, buyers should expect to submit a detailed plan, make a large down payment, and have a strong credit score to secure approval. The good news is that interest rates should be lower than for raw land loans.

Improved land loan

Improved land loans finance the purchase of plots that have been developed. Lenders prefer these parcels because they typically already have access to roads, electricity, and water. As a result, the sales price tends to be higher than for unimproved or raw land.

Lenders view financing these purchases as less risky investments. As a result, improved land loans usually have lower interest rates and looser eligibility requirements.

Loan qualifications

The exact eligibility requirements for a land loan vary by lender. Here are some general requirements that you can expect to need to meet to qualify for this financing option:

• A detailed plan explaining whether the land use will be residential or commercial
• A down payment of at least 25%
• Many lenders look for a credit score of 680 or higher
• A debt-to-income ratio (DTI) equal to or less than 43%
• Various property checks, including zoning verification with local municipalities, land-use restriction verification, land surveys, and utility checks

What does land use mean?

The term “land use” refers to how the land will be used and for which specific purposes.

Each local government determines how land in its jurisdiction will be used, preserved, or protected, and issues permits to builders accordingly. When it comes to land loans for building a home, governments want to know whether the land will be used for a primary residence or for commercial purposes.

Primary residences

According to the IRS, a primary residence is where you spend most of your time and the address that appears on your most important documents, like your driver's license and income tax return.

If the land is going to be the location of your future home, it must be zoned as residential or mixed-use. The designation affects everything from your local property taxes to the types of amenities that your neighborhood may boast.

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. These loans come with low interest rates, and borrowers may qualify for a lot loan with no down payment.

Commercial properties

Commercial use means that the land will be used for business purposes. Buying commercial real estate can be a worthy investment, though the application process is different. Lenders likely will ask for a business proposal and other supporting documents before approving the loan.

If you’d like to use a land loan for commercial purposes, you also can apply for an SBA 504 loan. SBA loans are provided by the Small Business Administration (SBA). They are intended for business owners looking for financing to purchase land. The interest rates and terms of SBA loans vary, but the repayment period typically lasts 10 – 25 years.

5 steps to get a land loan to build a house

While the application process may resemble that of getting a mortgage, some key differences make getting a land loan more challenging.

Here are the general steps you need to take to get a land loan.

1. Write a plan for the land

Lenders will ask you for a detailed plan for how you plan to use the land. The plan may require you to include the type of structures you plan to build, as well as whether you will be building a residence or running a business.

2. Pick the type of land you want to buy

After you've developed your plan, you should have a better sense of what specific type of land you'll need. For example, if you're looking to buy agricultural land that you can also live on, you'll want to choose partially residential land. You might also choose unimproved land if you want to build a home that aligns with your lifestyle.

3. Find a lender that provides land loans

Not every bank offers land loans. You'll have to do some research to find one, but it's often wise to start with local banks and lenders. Nearby providers know the area best and are likely more willing to invest in the region. Once you’ve settled on a few lenders, ask representatives about their application process so you can compare loan terms, conditions, and requirements.

4. Hire a real estate agent who specializes in land sales

A specialized real estate agent with experience in land sales can help you find a property and negotiate with land sellers. Experienced agents may have partnerships with sellers and banks that could make the closing process go more smoothly.

5. Prepare your documents and get preapproved

Once you’ve settled on a lender and an agent, you’re ready to start shopping for land. Gather all your documents, including your written plan for the property, and start an application with your chosen lender. It may take several business days to get a response, but the lender will make a decision and, if you're approved, provide a preapproval letter.

Pros and cons of land loans

Before you decide on a land loan, consider the following potential benefits and drawbacks.

Other land-purchasing options

A land loan isn’t the only way to purchase a plot of ground. Here are some alternative options.

Home equity loan

A home equity loan is a second mortgage secured by your home’s equity. You can borrow the equity from your current home to buy land to build another home.

Repayment terms vary by lender but generally last 5 – 30 years. If you default on the loan, you run the risk of losing your primary home.

Rocket Mortgage offers Home Equity Loans for primary and secondary residences.

Seller financing

Seller financing agreements are sometimes called land contracts. Seller financing involves the buyer making payments to the seller instead of paying them all at once. Essentially, the seller is lending the buyer the money to finance the purchase.

This can have its benefits, because sellers tend to be more flexible than financial institutions. It may be easier to qualify for a seller-financed loan than a traditional loan. Seller financing can be especially useful for aspiring land buyers who are struggling to qualify for a land loan or afford a large down payment.

However, keep in mind that your seller retains legal title to the property until you pay off the loan. Your seller also may charge you a higher interest rate, and the terms of your contract may be more vague than if you were dealing with a financial institution.

The bottom line: How to get a land loan

Securing a plot of land can be a thrilling step in designing and building your dream home or business. However, finding the right financing requires a bit of extra planning, gathering a larger down payment, and clearly organizing your development goals.

Are you ready to leverage your existing home's value to purchase the perfect parcel of land? Take the next exciting step toward your goals and start your Home Equity Loan application with Rocket Mortgage today.