If you're thinking about buying land, you'll be hard-pressed to persuade a mortgage lender to finance your purchase. Instead, you'll likely need to apply for a land loan.
Land loans aren't as common as mortgage loans, so your options may be limited. Also, because of different factors, you could end up with a shorter repayment period and higher down payment and interest rate than you'd find with a mortgage loan.
So, if you're considering getting a land loan, it's important to know what you're getting yourself into and what options are available to reduce your costs.
What are land loans?
Land loans are a type of credit you can use to buy a vacant lot to eventually build a home on or raw land that you don't intend to develop.
Land loans tend to be riskier for lenders than mortgage loans, says Casey Fleming, a mortgage adviser with C2 Financial Corp. in San Jose, California. And because of that, you may not get as favorable terms as you might get with a mortgage loan.
"Owners of raw land are much more likely to stop making payments and walk away from the property in the event of a financial event in their lives," Fleming says. "And land is much harder to sell (than a home)."
That's primarily because the demand for land is smaller than the demand for new and existing homes. So, if a lender needs to foreclose on the land, there's no guarantee it will get its money back in a timely manner, if at all.
As a result, some lenders require a substantial down payment and charge high interest rates on land loans. Also, some land loans have significantly shorter repayment terms than a typical 15- or 30-year term you might get with a mortgage loan.
5 land loans to consider to finance your land purchase
There are five common types of land loans you can get to finance your land purchase, each with its own terms and features.
1. Lender land loans
Community banks and credit unions are more likely to offer land loans than large national banks. Your best bet is to find a lender with a presence near the land you want to buy. Local financial institutions know the area and can better assess the value of the land and its potential.
If you're leaving the land undeveloped, interest costs will be very high, Fleming says. Plus, a lender could require a down payment as high as 50 percent.
Some lenders, however, may be willing to take a lower down payment and charge lower interest rates if you have plans to build on the land soon. So, shop around before you apply.
Also, local lenders are more likely to offer longer repayment terms, giving you more time to repay the debt.
2. USDA Rural Housing Site Loans
If you're planning on building a primary residence in a rural area, the U.S. Department of Agriculture (USDA) has a couple of loans that can help.
Section 523 loans are designed for borrowers who plan to build their own home, while Section 524 loans allow you to hire a contractor to build the home for you.
Both loans are designed for families with low to moderate income, and they have a repayment term of just two years. Interest rates, however, can be low. Section 523 loans, for instance, charge just 3 percent, while Section 524 loans charge the current market rate.
Depending on the situation, you may even qualify for a loan with no down payment.
3. SBA 504 Loan
If you're a business owner planning to use the land for your business, you may qualify for a 504 loan through the U.S. Small Business Administration (SBA).
With a 504 loan, you, the SBA and a lender help contribute to the costs of the land purchase:
The SBA provides a loan for 40 percent of the purchase cost.
A lender provides a loan for 50 percent of the purchase cost.
You contribute 10 percent in the form of a down payment.
SBA loans come with a 10- or 20-year repayment period, and the interest rate will be based on current market rates. The terms of the loan you receive through the lender can vary, however, depending on which lender you choose.
4. Home equity loan
If you have an existing home with significant equity, it may be worth getting a home equity loan instead of trying to get a land loan.
There's no down payment on a home equity loan. What's more, you can typically get a low interest rate – regardless of what you plan to do with the land – because your home secures the loan.
The downside is that if you default on the loan, you could lose your home. Also, since you're not using the loan to buy, build or substantially improve the home used as collateral, you can't deduct the interest you pay when you file your taxes.
Depending on the lender and the loan, your repayment term could be anywhere between five and 30 years.
5. Seller financing
In some cases, the person or company selling the land may be willing to offer short-term financing. In many cases, the seller isn't in the lending business and doesn't have a broad portfolio of loans like a community bank or credit union.
As a result, you can typically expect high interest rates and a high down payment. Also, it's unlikely you'll get a long repayment term. So, consider this option if you can't qualify for any other type of land loan.
How to find the right land loan for you
There's no single best land loan out there for everyone, so it's important to shop around to find the best one for your situation. Before you do anything, Fleming recommends developing a comprehensive plan for what you plan to do with the land.
Doing this can help you determine what type of loan is best and how long you want the repayment term to be.
Keep in mind, though, that some lenders may have limits on how much they're willing to finance. Others, Fleming says, may require a balloon payment, which is a large, one-time payment at the end of the loan term. "So, you may have to have a plan to pay it off before that payment comes due."
As you consider your different options, make sure you choose one that fits within your budget and helps you achieve your ultimate goal with the land.
This article was written by Ben Luthi and published in the Miami Herald.
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