Land loans allow borrowers to purchase a piece of land, often with the intention of building a home there or developing it for business.
Because of the inherent risk to lenders, land loans can be challenging to find. The rate and required down payment are typically higher than those of a traditional mortgage loan, and the repayment term is often shorter.
Let’s dig into land loans and look at some alternatives.
What Is a Land Loan?
A land loan, also referred to as a “lot loan,” finances a piece of land. Borrowers may have plans to build a home or start a business on the land, but they might want to keep the plot for just fishing or hunting. Developers can also get land loans to build homes or businesses.
A land loan is different from a construction loan, which is typically a short-term loan to build or rehab a home. With a land loan, the borrower might not have immediate plans to develop the land or build the house.
A land loan can be more challenging to obtain because, unlike with traditional types of mortgage loans, there is no home to serve as collateral for the lender. Thus, lenders may have stricter requirements and higher rates attached to a land loan.
First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.
Types of Land Loans
The land loan rate and terms you get — and the down payment you’re required to make — may depend on the type of land you’re trying to buy.
Raw Land
Securing financing for raw land can be challenging. Raw land, also called unimproved land, is entirely undeveloped, meaning it lacks roads and electrical, water, and sewage systems.
To improve your chances of loan approval, it’s a good idea to have a comprehensive development plan to show lenders.
Of course raw land is generally cheaper than land that has been partially developed, but because it is virtually untouched, it is not possible to know what major issues await when you start development.
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Improved Land
Because improved land is developed with utilities and road access, lenders may be more willing to offer financing. But the land typically costs more than raw land.
How to Find Land Loan Lenders
Finding land loan lenders can prove to be more challenging than finding a lender for a traditional mortgage.
Potential land buyers can try these routes for securing financing:
• Local banks and credit unions: If your personal bank doesn’t issue land loans or you’re struggling to find a big-name financial institution that offers them, you might have more luck with a local bank or credit union.
• Online lenders: Searching online allows you to compare land loan rates from the comfort of your couch. It also means you can read reviews about the lenders before applying.
• USDA loans for low-income borrowers: The U.S. Department of Agriculture offers Section 502 direct loans to help low- and very low-income individuals or households purchase homes or buy and prepare sites, including providing water and sewage systems, in rural areas. The rate is well under current market rates. The term is as long as 38 years. No down payment is required.
• SBA loans: Business owners planning to use land for a business may qualify for a 504 loan through the U.S. Small Business Administration. The SBA and a lender issue loans for a combined 90% of the land purchase cost. The rate is based on market rates.
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What Are Typical Land Loan Rates and Terms?
Like any other loan, the interest rate will largely depend on your credit score. That said, land loan rates are typically higher than traditional mortgage rates, thanks to the inherent risk and only the land as collateral.
And the repayment term? A land loan from a bank often is a five-year adjustable-rate loan with a balloon payment at the end. Rarely you might find a 30-year fixed-rate loan through a financial institution in the Farm Credit System.
The Federal Deposit Insurance Corp. (FDIC) recommends loan-to-value (LTV) limits. Lenders may set down payment requirements even greater than the FDIC proposes, however.
• For raw land, the FDIC advises a 65% LTV, meaning borrowers must put 35% down.
• For land development, the FDIC recommends a 75% LTV, meaning borrowers must put 25% down.
• For construction of a one- to four-family residence on improved land, the FDIC calls for an 85% LTV, meaning borrowers must put 15% down on the land loan.
If you don’t plan to develop the land, the rate and down payment could be steep.
If you do build a home on the land, you may be able to refinance the land loan into a traditional mortgage.
Alternatives to Land Loans
A land loan is not your only option when purchasing a lot. One of these alternatives to land loans may be a better choice for you:
Construction-to-Permanent Loans
If you plan to build a house in short order, this kind of loan could work. At first, you would make interest-only payments on the purchase price of the land. The loan then allows for draws until the house is done, usually 12 months from closing. The loan then converts to a permanent mortgage, sometimes with the same rate.
You may need to make a down payment of at least 20% of the total loan amount. The rate for construction loans in general is higher than a regular mortgage.
FHA, VA, and USDA single-close loans are also available to eligible borrowers.
Seller Financing
Though not as common as traditional financing, owner financing is when the current landowner acts as the lender. Also called a land contract, this type of financing does not involve a bank, credit union, or traditional lender.
While it can be beneficial for those who cannot secure a land loan, buyers have fewer consumer protections working in their favor.
Home Equity Loan or HELOC
If you have significant equity in your primary home, you may qualify for a home equity loan. Your home would serve as the collateral for the loan.
Similarly, you may be able to finance the land purchase with a home equity line of credit (HELOC) or a cash-out refinance.
How much home equity can you tap? Many lenders will let you borrow 85% of your home equity, the home’s current value minus the mortgage balance, but some allow more than that.
Personal Loan
Though personal loan rates may be higher than home equity products’ and you may need to pay off the loan in a shorter time, it might be possible to use a personal loan to finance your land purchase.
You’ll receive the funds quickly, and an unsecured personal loan requires no collateral.
What You Need to Know Before Applying for a Land Loan
Before applying for a land loan, it’s important to educate yourself about land development and to understand the details of the specific lot you’re interested in.
Survey
When buying a large plot of land, knowing the boundaries can be more challenging. Hiring a surveyor to mark the boundaries can be helpful before applying for the loan.
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Utilities and Roads
Unspoiled land may be beautiful, but it can be difficult to develop. Understanding what utilities and roads are available — or how to make them available and how much it will cost to do so — is important before applying.
Zoning
When considering a land purchase, it’s a good idea to research any zoning restrictions in that area. Before purchasing land, you’ll want to know that you can actually build on it the way you envision.
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The Takeaway
Land loans allow borrowers to purchase land to develop as they see fit. Because there is more risk involved for the lender, it can be challenging to find a land loan, and the rates and terms tend to be less favorable than those of typical mortgages.
A personal loan, cash-out refinance, home equity loan, or seller financing may also allow a land buyer to hit pay dirt.
SoFi offers fixed-rate personal loans from $5,000 to $100,000 and a cash-out refinance.
And SoFi brokers a home equity line of credit that allows qualified homeowners to access up to 95%, or $500,000, of their home’s equity.
FAQ
Is it hard to get a loan to buy land?
Getting a loan for a land purchase can be more difficult than getting a traditional mortgage. Fewer lenders offer land loans, and because there is more risk involved, they typically require a higher down payment, impose higher interest rates, and offer shorter repayment terms.
Are land loans higher interest?
Land loan rates are typically higher than traditional mortgage rates because there is no home to act as collateral for the lender. Interest rates may vary depending on credit scores and the down payment amount.
What is the first step to apply for a land loan?
First, research land loan lenders. Before applying, it’s also smart to devise a plan that shows the lender how you will develop the land, accounting for things like utilities, land boundaries, roads, and construction costs.
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