If you are considering raw land, you may need to finance the purchase if the plot is large or if it is in a prime location. But how do you do this?
The most common finance option is through a land loan lender. You can also get a loan through the Small Business Administration or the USDA. As with other loans you will have to meet qualifying standards like credit and you will also provide your intentions for the land.
This article explains what a land loan is and the various types that you may qualify for. We also include some considerations and how to improve your chances of getting approved.
Our experiences in the land acquisition business have taught us that people are often confused about buying or selling raw land. We want to provide you with the information you need to purchase the land that you have your eye on.
Table of Contents
What is a Land Loan?
A land loan is exactly what it sounds like, any loan used to buy a plot of land. The land could be used for home construction or other personal uses. It can also be used for business purposes or as an investment.
Raw land is completely undeveloped. This means it has no roads, electricity, or sewage systems. Sometimes it can be more difficult to get a loan for raw land, so you will want to be prepared to provide a detailed plan for the development of the land. Typically, loans for raw land have higher interest rates and may require a larger down payment, but this type of land will also have a lower price tag.
While raw land can be a great choice, there is also unimproved land. People sometimes believe that unimproved land is also raw land, but it is different because it will have some form of utilities even though it will not have an electric meter, gas meter, or phone box. Finally, there is improved land, which is developed land ready for use.
A land loan is similar to a mortgage loan in some ways, but it doesn’t have the collateral that a home or property can provide. Because of this, it can be a little riskier for lenders.
Types of Land Loans
In order to properly finance your purchase of raw land (or any type of land), you will want to check out the different options you may be able to take advantage of.
Lender Land Loans
This type is through a traditional lender like a bank or a credit union. A local or community bank is more likely to offer land loans than national banks. It is often best to look for a lender that is close to the desired land. This is because they are more likely to see the value of the land and its potential for development.
Some people are not planning on developing the land, which is okay as well. However, you may find that the interest rates are much higher and you may have to put down more, up to 50 percent in some cases.
If you are planning on going this route, be sure to shop around for different rates and terms.
USDA Rural Housing Site Loans
If you are planning on using the land to construct a primary residence in a rural location, then you may want to consider a couple of loans that the U.S. Department of Agriculture offers.
Section 523 loans are for those who are going to build their own home and Section 524 loans are for those who are going to hire a contractor to build the home. These loans are for low to moderate income families. The repayment term is only 2 years.
Interest rates for these types of loans are low compared to other types. Section 523 loans have a 3 percent interest rate and Section 524 loans have fixed interest rates lower than the current market standard rates. You may even be able to qualify with no down payment.
SBA 504 Loans
If you are a business owner planning to use the land for business purposes, you may be able to get a 504 loan through the U.S. Small Business Administration (SBA). 504 loans work by allowing both you and the lender to contribute to the land costs.
The SBA will loan 40 percent of the purchase cost of the land. The lender will provide another loan that equals 50 percent of the land cost. The final 10 percent will be a down payment that you have to put down in order to qualify.
The terms and interest rate on this type of loan will vary, but the interest rate is always based on current rates in the market.
Home Equity Loan
If you already have a home that has positive equity, then you can choose to get a home equity loan instead of a land loan. This means that there is no down payment and because of the collateral you will be able to get a low interest rate.
However, if you default on a home equity loan, then you risk losing your existing home. Repayment terms can vary greatly anywhere from 5 to 30 years.
Sometimes, the current land owner may be able to offer financing options. They may not be able to offer you the best terms or rates, but it is good for those who do not qualify for the other types of loans that you have available to use.
How to Get a Land Loan
Each different type of land loan has different qualifications. However, there are things you can do to help improve your chances of getting approved for any of them. Let’s look at some of the things that lenders will look for.
Credit score is one of the most important factors that can lead to approval or denial for a raw land financing option. The type of loan will determine the approval rates and qualifying credit scores, but improving your credit score before applying is always a good idea because it can help you get better terms and rates.
In addition to an excellent credit score, your loan application will go through other underwriting requirements. They may check your tax return or debt-to-income ratio. In some cases, a lender may even ask for additional collateral in order to secure the loan. They may request detailed and completed plans for the use of the land or the intended development. If you are going to develop the land, you may want to acquire city approvals and permits to show that the land will not remain raw for very long.
You will have to explain your intended use of the raw land. The use can depend on the type of loan that you apply for. You can get a loan if you are not planning on developing it or using it for personal use that is not a primary residence, but it may be more difficult to do so without a larger down payment or excellent credit score.
You will also be required to highlight land issues that need to be checked. This includes things like land use restrictions and zoning. It may also include a survey of boundaries and utility or road access. These things determine the level of risk for the lender.
Depending on the use, location, and other factors, raw land may be the best bet, but if you plan on developing the land soon, you may want to check unimproved and improved land opportunities as well.
After a lender takes all the factors into consideration, they will be able to issue the rates and terms of the land loan. The interest rates for land loans are usually higher than mortgage interest rates because they require a higher level of risk. You may be able to qualify for good interest rates if you have an excellent credit score and a low debt-to-income ratio. If you have the ability to lower your debt-to-income ratio before applying for the loan, you may find that it saves you a substantial amount of money on your rates.
Most land loans are shorter than traditional 30 year mortgages. This is because lenders usually do not want to hold a long term lien on raw or vacant land because it can lose value and may never be developed. However, you may be able to negotiate a longer term than the initial offer to slightly lower interest rates.
A higher down payment always increases the borrower’s chance of approval. The requirements vary by lender and sometimes have contingencies because of creditworthiness, development or land acquisition experience, and the purchase price or size of the lot.
Generally, the loan-to-value ratio, which is the amount of the loan divided by the value of the property, must be 90 percent or less for finished lots. This means that it would require at least a 10 percent down payment. However, it can be greater for undeveloped or raw land in some cases.
The down payment may increase up to 30 percent or even 50 percent. If you can save up more to put down before applying for a raw land loan, you may increase your chances of getting approved as well as securing good rates.
About THE AUTHOR
Brittany has been in the land business since 2020 when the world was starting to shut down because of COVID-19. Since then, we’ve sold to dozens of people from ATV weekend warriors to camping enthusiasts to retired truck drivers. Our inventory spans mostly in the western United States. We’ve been trained by experience, land acquisition courses, and hundreds of hours meeting with county assessors and clerks, zoning officials, realtors, and land investors. We’ve answered hundreds of questions from people regarding the buying and use of land.Read More About Brittany Melling