Understand Your Options for Buying Vacant Land

Many people consider buying land to build their dream home. If you're one of those people and you're looking for guidance, one key question you may have is whether you can get a loan to buy the land.

The good news is that you have options, which we'll break down to help you understand what you'll need when using a land loan to purchase land and build a custom home.

What Is a Land Loan and How Does It Work?

A land loan, often called a lot loan, is a specific type of financing used to purchase a vacant plot of land for future development or investment. Unlike a traditional mortgage that finances a home and the land it sits on, a land loan is used when the property doesn't yet have a structure.

Buyers may use these loans to purchase land for future building or hold the property as an investment. Because vacant land is generally harder to sell than a developed property, lenders often consider land loans to be a higher risk and may require larger down payments, higher interest rates, or stricter qualification standards.

Land Loans vs. Construction Loans

The main difference between land and construction loans is whether you're seeking funding for the land itself or for the construction of a home on land you already own.

The land loan helps you acquire the property itself. Once you own the land, a construction loan can cover the costs of building, including labor, materials, and utility installation. If you're planning to build your own home, you may need both loans.

Types of Land Loans

Lenders typically offer three types of land loans, each depending on the property's readiness. You can get loans for:

• Improved land: Property with existing road access and utilities is considered ready for construction. A loan for a ready-to-build plot can secure the land for when you're ready to build.
• Unimproved land: Plots with access to some utilities, such as water or electricity, are considered unimproved. For these plots, you'll need an unimproved land loan.
• Raw land: Property without utilities or road access is considered raw land. Lenders may offer loans for this type of property, but they often consider it the highest risk.

Are There Government-Backed Land Loan Options?

Government-backed mortgage programs typically don't offer loans to purchase vacant land on its own. Most government programs require a land purchase to be combined with the construction of a primary residence.

This means you may be able to use a construction-to-permanent loan, which finances the land purchase and the construction of your home together. Some options include:

• FHA One-Time Close Construction Loan: This loan allows borrowers to finance the purchase of the land, the construction of the home, and the permanent mortgage in a single loan.
• VA Construction Loan: Eligible Veterans may qualify for a construction loan that can finance the land and home build, often with no down payment required.
• USDA Construction Loan: USDA loans may allow borrowers in eligible rural areas to finance the purchase of the land and construction of the home together as part of a single mortgage.

Land Loan Requirements

Lenders often set higher qualification standards for land loans because these properties lack an easily profitable collateral, which in the case of mortgages is the house itself. While property can be seized if the loan is not paid back, its value and sales appeal are limited. Some key requirements buyers should be aware of are:

• Credit score: Lenders may require a credit score in the high 600s to low 700s.
• Debt-to-income ratio (DTI): Lenders may expect a DTI ratio of no more than 40%.
• Down payment: Depending on the type of land, lenders may require a down payment of around 35% for raw land, 25% for unimproved land, and 15% for improved land.

Remember: Exact requirements vary by lender, so it's important to discuss qualifications before applying. Additionally, you'll need to submit details on your intentions and the zoning regulations, which helps the lender verify that the property can legally be used as intended.

A Step-by-Step Financing Process for Land Loans

Getting a land loan usually involves a few more steps than financing a home that already sits on a lot:

1. Define: Plan how you'll use the land and ensure it meets zoning requirements, and provide this information to your lender as part of the process.
2. Verify: Check your financials, credit score, and DTI to ensure you meet lender requirements. Lenders usually have higher standards for land loans.
3. Prequalify: Once your finances are in order, get prequalified to help set a budget for the land.
4. Survey: Make sure the property has the necessary access to get the utilities you need. You'll also want a professional to conduct a survey, which may include soil testing if the property will rely on a septic system.
5. Choose: If you plan to build immediately, some lenders may require you to choose an approved construction company before finalizing the loan.
6. Apply: With everything lined up, it's time to submit your application to your lender.
7. Finalize: The lender will put the application through their underwriting process to verify your financial information and evaluate the land's value and legal status.
8. Close: If approved, attend closing, sign papers, and begin building or hold the land.

Pros and Cons of Financing Land Purchases

Anyone considering a land loan should weigh the potential benefits and risks before deciding whether to buy a plot of land or a lot with a home already on it.

Alternatives to Traditional Land Loans

A land loan isn't for everyone, so consider these alternatives:

• Home equity loan or line of credit: If you currently own a home that has equity in it, you may be qualified to borrow against that equity. A home equity loan or a home equity line of credit (HELOC) can be a good option.
• Construction-to-permanent loan: This loan gives you the money to buy the land upfront, and it also gives you an amount to draw from for construction costs. However, you must begin building right away.
• Seller financing: You may be able to borrow the money from the current landowner through a land contract or owner financing, but make sure you understand the terms. Seller financing often includes a balloon payment after several years.
• Personal loans: If you're buying a smaller plot, you could consider a personal loan. It may be quicker and may require no down payment, but personal loans often come with higher interest and shorter terms.

Final Thoughts: Is Buying Land the Right Move for You?

Buying land can be an exciting first step toward building your dream home. While land loans often come with higher down payments and stricter requirements, planning ahead can help you secure a loan.

If you're considering buying land and building a home, work with an experienced mortgage lender to explore financing options and get prequalified.