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What is a Land Loan?
A land loan is a type of loan that is specifically used for financing the purchase of a piece of land. This loan can be used for purchasing land for personal or commercial use, such as building a home, starting a business, or farming. Land loans are typically secured by the property being purchased, meaning that the lender has a claim on the land as collateral if the borrower defaults on the loan.
Where you buy land and what you want to do with it are two of the most critical factors determining the kind of loan you get and how easy it is to qualify. You can obtain land loans through a bank or an equal housing lender like mortgages. The community bank or lender will consider both your credit history and the land's value in deciding whether you are qualified to purchase the land.
How Land Loans Work
Land loans are similar to other real estate loans. A borrower applies for a loan to purchase a piece of land, and the lender evaluates the borrower's creditworthiness and the value of the property to determine the loan amount and terms.
One important factor in obtaining a land loan is the intended use of the property. If the borrower intends to build a home on the land, the lender may require a detailed construction plan and a timeline for completing the build. In some cases, the lender may also require additional collateral, such as personal assets, to secure the loan.
Another factor that affects land loans is the location of the property. Properties located in areas with high growth potential and stable real estate markets are often considered to be low-risk investments, which can result in lower interest rates and favorable loan terms.
Land loans typically have higher interest rates and longer repayment terms compared to other loans, such as a home mortgage. Borrowers should carefully consider their financial situation and the intended use of the property before taking out a land loan. It is also important to understand the terms and conditions of the loan and to compare the interest rates and loan terms offered by different lenders to find the best deal.
Land Loan Pros and Cons
Pros
- Potential for appreciation. Raw land or unimproved property has the potential to appreciate in value over time, which can make it a good investment opportunity.
- Potential for development. If you purchase raw land, you have the potential to develop it into a profitable investment, such as a residential or commercial property.
- Low maintenance costs. Unlike a home, raw land requires little to no maintenance, which can make it a lower-cost investment.
Cons
- High interest rates. Land loans often come with higher interest rates compared to other types of loans, making the overall cost of borrowing more expensive.
- Risk of development restrictions. Some areas have strict zoning laws that limit the type of development that can take place on a piece of property. This can limit the potential for profitability and make it more difficult to sell the land in the future.
- Difficulty in finding financing. It can be more difficult to find financing for a land loan compared to a traditional mortgage, as many lenders view raw land as a higher-risk investment.
- Risk of non-development. If you purchase raw land, there is a risk that it may never be developed and remain a non-productive asset.
Types of Land Loans
Construction Loan
The term "construction loan" refers to a loan taken out specifically to cover building expenses. A construction loan's term is shorter than a traditional mortgage and often ends when the building is finished. You will make loan payments to the construction team at certain stages once the right lender has authorized the project.
Construction loans typically require a credit score of 680 or higher, a 20% down payment, and comprehensive project plans that include an expected timetable and budget. There are numerous variables and more risks for lenders when building a dream home. Having a low debt-to-income ratio (DTI), a strong credit score, a stable income, and a desirable location are all other factors that can help you get a construction loan at a competitive interest rate.
Raw Land Loan
Lot Land Loan
Government Programs
The Department of Veterans Affairs (VA) and the Federal Housing Administration (FHA) offer homebuyers access to low-interest short-term loans to purchase land and construct a new primary residence. If you have built up a lot of equity in your house, you might be able to get a home equity loan and utilize the money for a home purchase. Your home's equity is the value over the amount still owed on your mortgage.
Borrowers who wish to construct buildings or develop land in rural regions may apply for grants and loans from the USDA or the United States Department of Agriculture. Land USDA loans with periods of 2 years and low-interest rates much below the market norm are made available to borrowers between 50% and 80% of the moderate-income families in the area. In addition, you can get in touch with a real estate agent on RB FCU's approved list.
If you need a loan to buy land for a business, the Small Business Administration (SBA) 504 loan program may be able to help. These loans are offered for 10- and 20-year durations, making them slightly more flexible than standard land loans. Borrowers must plan to use the funds for the construction or improvement of commercially used structures, infrastructure, parking lots, or landscaping.
How to Get a Land Loan
Getting a land loan requires careful consideration and preparation. These are some steps to help you get started:
- Determine your budget. Before you begin your search for a land loan, determine how much you can afford to borrow. It will help you narrow down your search to properties that fit within your budget and also help you understand what type of loan you will be able to qualify for.
- Identify your credit score. Your credit score is important in determining whether or not you will be approved for a loan, as well as the interest rate you will be offered. If your credit score is low, you may work on improving it before you apply for a land loan.
- Get pre-approved. Before you start shopping for land, it is recommended to get pre-approved for a loan. You will know how much you can afford and what interest rate you may be eligible for. This can also give you a better bargaining position when negotiating with the seller.
- Choose a lender. There are many different types of lenders that offer land loans, including banks, credit unions, and online lenders. Compare rates and terms from several different lenders to find the best one for you. You can do this by reviewing the terms yourself or requesting a loan officer to help you.
- Submit your loan application. Once you have selected a lender, you will need to submit a loan application, including all the required documentation. This typically includes financial statements, proof of income, and a credit report.
- Review and credit approval. Once your loan application has been submitted, the lender will review it and make a decision on your loan. If you are approved, the lender will provide you with a loan agreement detailing the terms and conditions of the loan.
- Close on your loan. Once the loan agreement has been signed, the lender will fund the loan, and you can close on the purchase of your land.
Ways to Pay Land Loans Back
Paying back a land loan is similar to paying back any other type of loan. Here are the steps to follow:
- Know your payment schedule. Before you take out a land loan, make sure you understand the payment schedule. This will typically include the due date and the amount that you need to pay each month.
- Set up automatic payments. To avoid late fees, consider setting up automatic payments from your bank account to your lender. This way, you can ensure that your payments are made on time every month.
- Stay on top of interest. Land loans typically have a higher interest rate than other types of loans. Keep an eye on the interest rate and try to repay the loan as quickly as possible to minimize the amount of interest you pay over time.
- Make extra payments. If you have additional funds available, consider making extra payments to reduce the total amount of interest you pay over time.
- Be mindful of balloon payments. Some land loans may have a balloon payment, which is a lump sum payment due at the end of the loan term. Make sure you have the plan to pay this amount when it comes due.
- Consider refinancing. If you have a high-interest land loan, you may be able to refinance it to get a lower interest rate and reduce your monthly payments.
- Keep in touch with your lender. If you cannot make your payments, reach out to your lender as soon as possible. They may be able to offer you a loan modification or other options to help you get back on track.
By following these steps and paying the loan on-time the terms of your loan, you can successfully pay back your land loan.
Legal Regulations
The FDIC or Federal Deposit Insurance Corporation has set up lending policies that have been issued to institutions regarding the loan-to-value limitations for land. These limitations are in place to protect depositors. The loan terms can be as flexible as the lender sees fit, but they must not exceed what the FDIC considers acceptable.
The construction of a single-family home with up to four units requires a 15% down payment (or a maximum loan-to-value ratio of 85%). On the other hand, the FDIC places a limit of 75% on the loan-to-value ratio for land development, which often necessitates a deposit of up to 25%. After that, you could make a healthy profit by selling the land to the developer. Even though the maximum loan-to-value allowed by the FDIC is 65%, lenders may nevertheless feel forced to require down payments of at least 35%, even in low-risk situations.
