What property buyers should know about land loans

Looking to buy some land? You have plenty of options, from modest suburban lots to massive 5,000-acre ranches.

You probably won’t be able to finance a land purchase with a regular mortgage, though. If you’re not sitting on enough cash to buy the land outright, you’ll need to explore land lease options or apply for a land loan, also often called a lot loan or property loan. Read on to learn more about land loans, how they differ from conventional mortgages and what you’ll need to get approved for one.

What is a land loan?

A land loan is used to finance the purchase of a tract of land. Unlike a construction loan, which helps you borrow the money for land and the building process, land loans are meant solely for buying the land. How you finance will likely depend on what type of land it is:

• Raw land: This type of land typically doesn’t have access to utilities; it may not even be accessible by road. Raw land is generally more inexpensive than the alternatives, but it can be difficult to get financing for.
• Unimproved land: Unimproved or undeveloped land — an upgrade to raw land — may have access to some utilities but still lack others, such as phone lines or a meter for gas or electricity. Obtaining financing for unimproved land is easier than for raw land, but can still be challenging.
• Improved land: Many buyers prefer improved land because it is already developed with full utility and road access. While it’s the most expensive type of land, it’s also the easiest to finance.

How do land loans work?

Because land loans carry more risk than conventional mortgages, lenders tend to charge higher interest rates for them. (Deals can be found, though, especially with smaller community banks and credit unions.)

Rates for raw-land loans will usually be around 2 percent higher than conventional mortgage rates, says Lou Jewell, owner of LandPro Real Estate in North Carolina and an accredited land consultant who hosts the podcast “Let’s Talk Land.”

Additionally, many lenders will want to see at least a 15 percent down payment — and potentially much higher, depending on market conditions. “During the economic downturn caused by the pandemic, down payment requirements surged to 20 and 25 percent,” Jewell says.

In addition to higher rates and higher down payment requirements than traditional mortgages, getting a land loan may require a higher credit score too. Credit-reporting agency Experian advises that borrowers should anticipate needing a score in the high 600s to the low 700s at a minimum.

Borrowers should also have a detailed plan for how the land they buy will be used. “A lender is going to want to know what you plan to do with it,” Jewell says. “Is it going to be a business? A hobby? You’ll need to outline whether there will be animals and certain types of flora and fauna.”

In many ways, though, land loans are similar to any other type of borrowing. They have debt-to-income ratio requirements similar to conventional mortgages, for example, Jewell says. And the rate you’ll receive is tied to your down payment amount and creditworthiness. The typical repayment timeline is 20 years, not 30 — though loans with significantly shorter terms can be found. Some land loans might even be structured as balloon mortgages, with interest-only or no payments for a set time, then the balance coming due in one large payment.

Types of loans for land purchase

Because these loans tend to be more expensive, it’s all the more important to compare multiple types and lenders before you settle on one.

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 usually know the area and can better assess the value of the land, and its potential.

USDA Rural Housing Site loans

If you’re planning to build a primary residence in a rural area, the U.S. Department of Agriculture (USDA) has two loan options to consider:

• Section 523 loans, designed for borrowers who plan to build their own home.
• Section 524 loans, which allow you to hire a contractor to build a home for you.

Both are meant for low- to moderate-income families and have a repayment term of just five years. The interest rates, however, can be low. Section 523 loans, for instance, charge just 3 percent, while Section 524 loans charge less than the current market rate, with the rate on your specific loan fixed at closing.

SBA 504 loans

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.

The interest rate on a 504 loan is based on current market rates. The other terms of the loan can vary by lender, however.

Home equity loans

If you already have a home with significant equity, it might be worth getting a home equity loan instead of a land loan. There’s no down payment required on a home equity loan, and you can typically get a lower interest rate than a personal loan, since it’s secured by your home.

Of course, that’s also a big downside: 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, the interest you’ll pay is not tax-deductible.

Pros and cons of land loans

Land loans are used in pretty specific circumstances, so they’re not useful for a huge share of homebuyers. Here are some ways they might make sense for you and some ways they won’t:

Pros

• Simple way to finance if you’re buying an empty lot to build a new home for yourself
• Government programs may help you get low interest rates with low or no down payment required
• Can help small business owners get established in a new location

Cons

• May be difficult to find a lender
• May be charged a high interest rate or need to tap your home equity if you don’t qualify for a government program, which could jeopardize your current property
• Could have a short repayment period, which means high monthly payments until the debt is paid off

How to get a loan to buy land

• Develop a plan: Before you start looking for a loan, outline a comprehensive plan for what you want to do with the land. That can help you determine what type of loan and terms are best for your goals. It may also increase your chances of getting approved for a loan later — many lenders won’t approve a loan without knowing what you intend to do with it.
• Check your credit score: Don’t do yourself a disservice by applying for a land loan with a low credit score. Check your score now and make a plan for getting it up to around 700 (if you’re not there already). This might require some time, so start early.
• Search for land: Websites like LandWatch, LandSearch and Land.com are useful to search for land based on your preferences and intentions.
• Find an agent with land experience: Jewell recommends looking for an agent who’s a member of the Realtors Land Institute. Someone with the “accredited land consultant” designation will have the expertise to help you find the right plot of land and secure the right kind of funding to buy it.
• Shop around for the right lender: As with any other type of loan, it’s important to comparison shop. A quick online search for land loan providers in your area is a good place to start. It’s also worthwhile to get in touch with small local lenders and credit unions, as they may be more likely to offer this kind of financing.

FAQs

• Can you finance land?

  Yes. You can finance the purchase of a tract of land if you plan to build a house on it or use the land for business purposes. Land loans can be more expensive and difficult to get than traditional home loans, though.

• What is a good credit score for a land loan?

  Credit-reporting agency Experian advises that your credit score should be in the high 600s or low 700s, at least, to secure a land loan. In addition, it says your debt-to-income ratio should be no higher than 43 percent.

• Are land loan rates the same as mortgage rates?

  No. Land loans carry more risk than traditional mortgages, so lenders typically charge higher interest rates — particularly on raw land that lacks access to basic utilities. However, there are exceptions to this rule. Compare offers from multiple lenders to find the most competitive rate possible.