Land Loans: Everything You Need To Know

*As of July 6, 2020, Rocket Mortgage® is no longer accepting USDA loan applications.

Sometimes when potential home buyers are looking to buy a house, they start to consider building one instead.Before going down this road, borrowers should determine what it might cost to build a house and buy the land to build it on. Though building a house can be expensive, there are many ways to make it more feasible for first-time homeowners. Land loans are one of these resources.

If you choose to build a house, chances are you’ll apply for a land loan. While Rocket Mortgage® doesn’t offer land loans or lot loans, we understand the importance of providing real estate insight and know-how, and we can help point you in the right direction to find the right lot for your new home.

What Is A Land Loan?

A land loan – sometimes referred to as a lot loan – is used to finance the purchase of a plot of land. You can take out a land loan if you’re interested in buying a piece of land to build a home or use for business purposes. The type of loan you take out will depend on where you’re buying land and how you intend to use the land.

A land loan is sometimes confused with a construction loan, which is another type of loan often used by people looking to build a house. So, what’s the difference? Typically, if you want to buy land and start building on it right away, you get a construction loan. These short-term loans are intended for prospective home builders who want to start on their construction project right away and have everything planned and ready to go.

Land or lot loans, on the other hand, are a better choice for future home builders who have a plan but may not want to jump right into building and financing a house. If you have circumstances pushing your building project out a year or so (or you’re still getting your home plans together) a land loan is likely a better choice for you.

While Rocket Mortgage doesn’t offer land or construction loans, you can still qualify for a mortgage on a new-construction house. We can also help you refinance an existing construction loan into a traditional mortgage onceyour new home is built. The home must be finished and have a Certificate of Occupancy.

Types Of Land Loans

The three most common land loans are raw land loans, unimproved land loans and improved land loans.

Raw Land Loan

Raw land refers to a completely undeveloped area with no electricity, sewers or roads. Because it can be hard to get financing for undeveloped land, it’s important that you create a solid, detailed plan for how you want to develop the land. This will show lenders that you’re committed to the project and don’t pose a great risk.

You can also increase your chances of qualifying if you make a large down payment (typically 20% or more) and have good credit. While the purchase price of raw land can be cheaper than developed land, raw land loans have higher interest rates and require larger down payments than other land loans.

Unimproved Land Loan

Unimproved land is similar to raw land, but it tends to be more developed. Sometimes unimproved land has some utilities and amenities, but it typically lacks an electric meter, phone box and natural gas meter.

While an unimproved land loan isn’t as risky as a raw land loan, it can be difficult to get. To improve your chances,make sure you have a detailed plan, a large down payment (20% down or more) and a strong credit score. Because unimproved land loans aren’t the riskiest loan type, the down payment requirements and interest rates won’t be sky-high, but it’s common for them to be higher than other types of loan financing.

Improved Land Loan

Unlike raw land and unimproved land, improved land has access to things like roads, electricity and water. Improved land is the most developed type of land, so it may be more expensive to purchase. However, the interest rates and down payments for improved land loans are lower than raw land loans or unimproved land loans. Nonetheless, you still need to make a significant down payment and have a good credit score.

How Do Land Loans Work?

A borrower obtains a land or lot loan the same way a home buyer obtains a mortgage loan. However, it can be harder to determine what the land is worth because there is no property collateral.

This means that land loans are a riskier transaction for lenders, which results in higher down payments and interest rates than a typical home loan. Let’s explore how to buy land to build a house.

Loan Qualifications

Each land loan type has qualifications borrowers must meet. However, there are still general requirements borrowers must meet to apply for a land loan:

• Have an excellent credit score (720 or higher)
• Explain the intended use of the land
• Highlight necessary property checks, like zoning, land-use restrictions, surveyed boundaries and access to utilities

Once a lender considers these factors, the rates and obligations of the land loan can be issued. Land loan interest rates tend to be higher than mortgage interest rates because they’re riskier. However, a borrower can qualify for lower rates if they have a better credit score and a low debt-to-income ratio (DTI).

Lending Process

After the loan’s rates are determined and the borrower is approved, the borrower must make a down payment and pay the loan back in installments for the determined interest rate.

Once the construction of your new house is complete, you can refinance your land loan into a traditional mortgage. Refinancing can help you secure a new principal balance and lower interest rate. To refinance to a traditional loan with Rocket Mortgage, construction must be fully completed and you must have a Certificate of Occupancy.

Pros And Cons Of Land And Lot Loans

If you’ve considered applying for a land loan, you’ve likely realized that there are some benefits and drawbacks. To help make your decision easier, let’s go over some pros and cons and see how they’d apply to your needs and financial situation.

Pros