How To Get A Loan To Purchase Land

If you’re wondering how to get a loan for land, wonder no more. We have all the information you need. That said, it also helps to note that the process of securing loans for land purchases differs significantly from obtaining other forms of real estate financing.

Before diving in, though, it’s important to be aware upfront that there are unique costs associated with building a house on land from scratch and that electing to do so can be expensive. Home buyers who choose this route should expect to pay for several contractors, permits, and materials. One of the largest investments that they’ll make is acquiring a plot of ground on which to situate their property – which is where a loan for land purchases comes in.

On top of it, unless home buyers have a significant amount of money put aside, those seeking to go this route will have to apply for a land loan as well. That’s an important distinction to be aware of, noting that the loan which you’ll use for the purchase is separate from the form of financing used to build the physical house itself – and that the process of obtaining it is different from getting a mortgage. Even though Rocket Mortgage® doesn’t offer these types of loans, we want to help you before you start your home building journey. Here’s what you should know.

What Is A Land Loan?

In simple terms, a land loan – which you may sometimes hear referred to as a lot loan – is used to finance the purchase of a plot of land. As a prospective property owner, you can choose to take out a land loan if you’re interested in buying a piece of land upon which to build a home or that you intend to use for business purposes. That said, the type of loan that you elect to take out will depend on where you’re buying the ground and how you intend to use it.

For those curious how to get a loan for land, and if applying for one even makes sense, be advised: Land or lot loans are often great choices for people who aren’t ready to build or finance the physical house, but know they want to live in a specific area. For example, using the financing method, a person who is 10 years away from retirement can purchase land in another state, then begin building the house 5 years later. In effect, a land loan provides a great way to secure the plot of earth that you want to reside on, then build a house at your leisure, versus shopping for a prebuilt home.

Construction Loans Vs. Land Loans

Note that a construction loan is another type of loan that you can utilize if you’re seeking to finance building a new house. However, construction loans won’t cover the costs associated with buying land.  And the terms associated with the financing products are shorter than those associated with land loans as well. Borrowers who choose to seek out and secure construction loans tend to be prospective homebuilders with projects that start once the financing has been obtained.

All of which is to say that you’ll need at least two loans if you’re planning on building a new house for yourself or prospective tenants: Both a land loan and a construction loan. The land loan effectively covers the purchase of the land itself while the construction loan is designed to cover the cost of building infrastructure.

While the prospect of securing two loan financing options (let alone from different lenders) may seem financially daunting at first, don’t forget. You also have the option of purchasing a new construction house with a mortgage attached. Yet another potential avenue you might explore is refinancing the construction loan with a mortgage loan once the construction of the property is complete. Whatever the case, be advised that borrowers will need to furnish several documents during closing, including a Certificate of Occupancy.

Types Of Land Loans

As a potential borrower, you can leverage three distinct types of land loans that are available to prospective homebuilders: raw land, unimproved land, and improved land. Let’s take a closer look at the main differences that you should be aware of and consider when weighing your options while you’re shopping for land.

Raw Land Loan

Financing raw land comes with the most difficult type of loan to secure. That’s because the land will need electricity, sewers and roads to be installed upon it in order to support the building of your property. Therefore, most lenders will want to see detailed plans for how and when development will be completed. Otherwise, potential financiers will deem the investment too risky and deny the application.

As you might imagine, prospective lenders generally consider raw land to be a riskier investment. To maximize odds of obtaining lender approval, borrowers should be prepared to offer a larger-than-average down payment alongside their written plan. Many land loan lenders ask for 20% or more of the purchase price to be furnished upfront, and that prospective borrowers sport good or excellent credit scores.

Keeping all this in mind, don’t forget you’ll also want to shop around for potential lenders as well. It’s best to take the time to compare financing options and providers before applying in order to make sure that you get favorable terms, because while raw land may be cheaper than more developed land, there are also hidden costs attached. For example, raw land loans often come with higher interest rates compared to traditional mortgages or other land loans. It’s better to take the time to do your research and compare terms from at least three to five financial providers before investing your time and money in applying for a raw land loan.

Unimproved Land Loan

Unlike raw land, unimproved land already comes with some amenities preinstalled like water or electricity. At the same time, there may also be significant improvements that you’ll need to invest in before it’s livable. Such investments may include things like cisterns, or phone, internet or natural gas lines. Buyers who invest in unimproved land will have to get a clear picture of what has and hasn’t been done to the property (and what still remains to be done prior to purchase) before putting in an offer.

Note that unimproved land loans are generally difficult to secure. While lenders deem this type of option less risky than a raw land purchase, buyers should expect to submit a detailed plan, offer a large down payment, and a strong credit score during the application process. The good news here being that interest rates shouldn’t be as high as those associated with raw land loans, however, they are often higher than many may expect.

Improved Land Loan

Like the name implies, improved land loans are designed to facilitate the purchase of plots that have the most development. These parcels of land are preferred because they typically provide access to roads, electricity and water. As a result, the sales price tends to be higher for such parcels of ground as opposed to unimproved or raw land. 

As a quick overview, the benefits of purchasing improved land are: 1.) banks view financing these purchases as less-risky investments; and 2.) homebuilders will have to do less work upon the land itself. Nevertheless, the application process for obtaining an unimproved land loan is the same as with other loan types. Choosing this type of land as your desired purchase and place to situate a property depends entirely on what type of offering that homebuilders want and are willing to invest in.

How Do Land Loans Work?

As you may have surmised by now, the most critical (and hardest) part of buying land to build a house on is securing financing. Generally speaking, a borrower must obtain a land or lot loan the same way a home buyer obtains a mortgage loan. However, potential lenders can find it harder to determine what the land is actually worth because there is no collateral such as a house or farm equipment attached.

As a result, lenders see land loans as potentially riskier investments. To offset this risk, loan products typically come with higher down payments and interest rates attached than with a standard home loan mortgage.

What Does Land Use Mean?

Land use means exactly what it sounds like: how the land will be used and for which specific purposes. Every local government determines how land will be utilized, preserved, or protected and issues corresponding permits to builders based on these decisions. As it relates to land loans for building a home, governments want to know if the land going to be a primary residence or a commercial property.

Primary Residences

Per IRS regulations, a primary residence is defined as where you spend most of your time and the address that appears on your most important documents like driver's licenses and tax returns. 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.

Note that 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. The financial products come with low interest rates attached, and depending on their situation, borrowers may qualify for a lot loan with no down payment as well.

Commercial Properties

Commercial means that the land will be used for business purposes. Developing and buying commercial real estate can be a worthy investment, however, the application process for obtaining land is slightly different than that intended for residential needs. Lenders will likely ask for a business proposal and other supporting documents before approving the loan. Be sure to discuss any plans that you may have for commercial land with your realtor before going land shopping.

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

Loan Qualifications

Below, you’ll find the general requirements that borrowers must meet in order to apply for a land loan:

• A detailed plan explaining the intended use of the land (residential or commercial). 
• A good or excellent credit score (670 and above).
• Complete various property checks, such as: zoning verification with local municipalities, land-use restriction verification, land surveys, and utility checks, like water and utility

Also keep in mind that application requirements, rates, and contractual terms and obligations for a land loan are determined by individual lenders themselves. As a potential borrower, you should be clear about what requirements and agreements that lenders are asking for before you begin the application process. On the bright side, select borrowers can qualify for more favorable terms and interest rates if their debt-to-income (DTI) ratio is low and they have a healthy credit history to back their application up with.

How To Get A Loan For Land Purchases

As previously mentioned, getting a land loan can be difficult. While the application process may resemble that associated with obtaining a home mortgage, there are some caveats. Let’s take a quick walk through the basics.

1. Write Down Your Plan

As opposed to the process associated with a mortgage application, 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 or if you will be running a business. While having to put together a plan may seem tedious, don’t forget that assembling a planning document will make the process of securing financing and shopping for land easier.

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 that you’ll need. For example, you’ll likely want to purchase agricultural land that’s partially residential if you want to build a homestead – and you might choose unimproved land so that you can build a homesite that matches your lifestyle choices.

3. Find A Lender That Provides Land Loans 

Not every bank offers land loans. You’ll have to do some homework to find one, but as you do your research, you may find it helpful to start with local banks and lenders. Nearby providers tend to know the area best and are 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

You could search for a plot of land that best matches your needs and wants yourself. But you may find the process daunting because of how long it takes. Hiring a specialized real estate agent may save you the headache of finding and negotiating with land sellers. Plus, experienced agents may have existing partnerships with sellers and banks that could make the closing process go more smoothly for you.

5. Prepare Your Documents And Get Preapproved

Once you’ve settled on a lender and an agent, you’re ready to start shopping! Gather all your documents, including your written plan from step 1, and start the application with your chosen lender. It may take several business days to get a response, but the lender will make a decision and issue you a preapproval letter. Now, you can confidently shop for a parcel of land with your financing secured.

Pros And Cons Of Land Loans

There are several benefits and drawbacks to getting a land loan. Here are some things you should consider before you apply for one.

Pros

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. Other perks include:

• You have an opportunity to build the home of your dreams.
• If you are a business owner, you could capitalize on developing areas and growing markets to enjoy greater returns on investment.
• You can buy now and build your home at a preferred date in the future.

Cons

At the same time, there are also certain tough realities to getting a land loan. Here are a few things to consider:

• Lenders view land loans as riskier than mortgages and have more stringent criteria for approval.
• You may need to furnish a higher down payment to secure one.
• Your credit score needs to be higher than average to obtain financing, and your DTI ratio must also be lower than average.

Other Land Purchasing Options

Note that securing a land loan isn’t the only way to purchase a plot of ground. If you’re interested in buying a certain locale, the following options may also present a welcome alternative.

Home Equity Loan

Home equity loans effectively function as a second mortgage that enable you to use some of your existing home’s equity to make the purchase. You won’t be required to submit a down payment, and interest rates tend to be lower no matter what you plan for the land, as your home is used as collateral to secure the loan. That said, interest that you’ll pay on the loan is not tax deductible since you won’t be using the loan to buy, build or improve the home which secures it.

Bear in mind that loan repayment terms vary by individual lender, yet generally last 5 – 30 years. Of course, if you default on the loan, you run the risk of losing your primary home, so you’ll want to be sure to make timely payments.

Should you be interested, Rocket Mortgage is now offering Home Equity Loans, which are available for primary and secondary residences.

Seller Financing

On the flip side, seller financing also tends to be a desirable option for certain borrowers. Seller-financed land agreements are sometimes called land contracts. Any given contract is a real estate agreement where the seller acts as a lender and directly handles the mortgage process. In other words, rather than apply for a traditional mortgage, as a buyer, you’d sign a contract directly with a seller.

As a financing option, it can be beneficial for buyers because sellers tend to be more flexible than financial institutions. In practical terms, that means that 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.

Of course, you’ll also want to note that legal homeownership can be a bit of a gray area when paying for a seller-financed property. While you will receive an equitable title, your seller retains the legal title of the property until you pay off the loan, which can cause potential headaches down the road is a dispute arises. Your seller may also charge you higher interest rates and the terms of your contract may be vaguer than when dealing with a financial institution.

The Bottom Line: How To Get The Right Land Loan

Even though it tends to be more difficult in general to obtain a land loan, applying for one may be worth it if you want to build your dream home. Take the time to do your homework and research all your options before you seek out a lender to help finance your land purchase. If you choose another route to finance your dream, consider applying for a Home Equity Loan with Rocket Mortgage today.