How To Use A Land Loan To Finance A Property Purchase (2024)

Building a home or office from scratch certainly isn’t for everyone, but it can be a rewarding experience that allows you to craft your vision of the ideal property. Before you draft blueprints and browse fixtures, however, you need to know where that home will stand. In other words, you need to own some land.

Financing the purchase of a tract of land is different than taking out a loan for an existing home or commercial property. In fact, you won’t go through a traditional mortgage lender. You will need a land loan, which may have worse terms than a home loan. But don’t let that stop you from pursuing your goal of owning land. Here’s what you need to know.

What Are Land Loans?

A land loan can be used to finance everything from a raw plot of land to a vacant lot and construction of a new building. It can be used for land that will host a personal home or a business. Land loans are considered riskier than a mortgage or many other types of loans because:

• Default rates are higher on land loans than home loans. There are many reasons you could default on the loan—maybe construction plans fall through or you run out of money.
• Borrowers are more likely to walk away. If they run into financial trouble, they’ll value saving the home they live in over a piece of land.
• A vacant plot isn’t ideal collateral. If you do fail to make your payments, your unimproved land is less attractive than property that can go to foreclosure auction.

Land loans tend to come with higher interest rates and more strict down payment and credit requirements than other types of property loans because of these risks to the lender.

What to Know When Buying Land

The terms of your land loan will depend on the type of loan you get, your plans for the land and the particular lender you work with. In general, there are three types of land that lenders will consider financing—raw, unimproved and improved land—all of which come with their own pros and cons.

Raw Land

Raw land is land that is undeveloped. There’s no plumbing, electricity or access to nearby roads. Essentially, it’s a blank slate for you to work with. Not surprisingly, raw land tends to be cheaper than developed land, but know that it could cost you more in the long run.

Buying raw land is a risky prospect to lenders, so they often compensate by charging higher interest rates and requiring higher down payments. In fact, you may need to put down 50% or more if the purchase is speculative, meaning you are hoping property values will rise.

As with most types of loans, a good credit score and solid down payment will help you get approved for a raw land loan and qualify for the best terms. It also helps if your intention is to begin development right away and you have a clear, detailed plan for how you will use the land.

Unimproved Land

Next is unimproved land, which is somewhat open to interpretation and sometimes synonymous with raw land. Generally, though, unimproved land refers to land that has access to some basic utilities, but is still lacking major items such as an electric meter, phone box or natural gas meter. In other words, there are few added improvements to the plot.

It may be a bit easier to qualify for an unimproved land loan over a raw land loan, but it’s still considered risky. Again, you should have a solid credit score, down payment and plan for the land.

Improved Land

Improved land is the most expensive option since it’s fully developed and construction-ready. It’s also often easier to qualify for this type of land loan, and lenders offer lower interest rates and down payment requirements.

Types of Land Loans and How to Get One

Once you’ve saved up a down payment, developed plans for your land and have a solid credit score, it’s time to look around for lenders. Land loans aren’t as easy to come by as mortgages, but you do have several options.

Local Banks and Credit Unions

One of the best places to look for a land loan is your community bank or credit union. Local financial institutions will have a good idea of how the surrounding land can be used and have more flexibility when it comes to working with customers.

The U.S Department of Agriculture (USDA)

The USDA provides land loans to borrowers who plan to build a primary residence in a rural area. If you plan to build the property yourself, apply for a Section 523 loan through the USDA. The interest rate on these loans is just 3%. Or if you want to hire a contractor to build it for you, apply for a Section 524 loan, which charges interest based on the current market. It’s possible to qualify for no down payment, but you must repay the loan within two years.

The U.S. Small Business Administration (SBA)

You also can potentially secure a land loan through the SBA if you plan to purchase land where you’ll build the facilities for a small business. The SBA offers two types of land loans, including the:

• Certified Development Company (CDC) loan. This is also known as the 504 loan program, which allows you to borrow up to $5.5 million for a term of 10 to 25 years. You’re expected to put down 10% of the loan, while a third-party lender finances at least 50%, and the CDC provides up to 40%. In order to qualify, your business must be worth less than $15 million and your net income must be $5 million or less for the two years before applying.
• SBA 7(a) loan. These loans provide up to $5 million for terms of up to 25 years. You must contribute a 10% down payment, and if the loan is more than $25,000, you may also be required to provide collateral.

Direct from the Seller

Finally, you may be able to work out a financing deal directly with the person who is selling the plot of land. This option may eliminate the hassle of tracking down a third-party lender and applying for a loan, but an individual seller may want to receive a much larger down payment and be repaid within a couple of years. Be sure that if you do take this route, you get the details of the agreement down on paper and even consult with a lawyer.

Alternative Options to Financing Land

Though there are a few different options for financing a land purchase, you don’t necessarily have to go one of those routes. There are also a few financing alternatives that you may find more ideal than a traditional land loan. Before pursuing one of these options, however, it’s important to carefully weigh the risks.

• Home equity loan or line of credit: If you already own property that’s appreciated in value since you purchased it, you may be able to leverage the equity to buy additional land using a home equity line of credit (HELOC) or home equity loan. You won’t have to make a down payment, but this can be a particularly risky option because you could lose your home if you default on the loan.
• Personal loan: Another option is to take out a personal loan, which can be used for just about anything. You may want to consider this option if the loan amount is on the smaller side and/or the land is in a condition that would make it tough to qualify for a traditional land loan. Just keep in mind that because the loan is unsecured, the interest rates can be as high as 30% (especially if you have fair credit).
• Buy a teardown: One workaround to securing an actual mortgage loan for a land purchase is buying a property that you plan to tear down and rebuild. Of course, this option is not without its own potential costs and roadblocks. You’ll need to secure permission from your lender and the appropriate permits, as well as pay for demolition.

Where to Find the Best Land Loan Lenders

If you’re ready to pursue a land loan, one of the best places to start is your own backyard. Local lenders will have the ability to assess the land and its potential, as well as the flexibility to offer better terms. You can also turn to the web. Online lenders have little overhead, which means they can pass on those savings to you in the form of lower rates and fewer fees.

Whichever lender you choose, be sure to spend time evaluating all of your options and crunching the numbers. There may be many options for securing a land loan, but many aren’t cheap.