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Land Loans: Everything You Need To Know

Emma Tomsich7-minute read

May 05, 2022

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

Sometimes when potential home buyers are looking to purchase a home, they may also consider building one. The thought can seem perfect until future homeowners realize what it might cost to build a house. 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 might have to apply for a land loan. While Rocket Mortgage® does not offer land loans or lot loans, we understand the importance of educating our clients.

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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 to utilize for business purposes. The type 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’ll want a construction loan. These short-term loans are intended for prospective home builders who want to get started on their project right away and already 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 immediately. 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 after your new home is built, given the home is finished and you obtain a Certificate of Occupancy – whatever option works best for you. 

Types Of Land Loans

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

Raw Land Loan

Raw land is completely undeveloped land 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 as great of a 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 do have higher interest rates and require more significant down payments compared to 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 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 still be difficult to obtain, so make sure you have a detailed plan, large down payment (20% down or more) and a strong credit score. Because unimproved land loans aren’t the riskiest type of loan, the down payments 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, interest rates and down payments for an improved land loan are lower than they are for a raw land loan or unimproved land loan. Nonetheless, it's still important to make a significant down payment and have a good credit score.

Land and lot loans are obtained in the same way a buyer would obtain a mortgage loan for a house, but unlike receiving a dollar amount assigned to the property, 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 payment requirements and interest rates than a typical home loan.

How Do Land Loans Work?

Because there are different types of land loans, each has its own qualifications for borrowers to meet. However, there are still general guidelines that are taken into consideration when a borrower applies for a land loan. 

As with any loan, a borrower will need to prove they have a good credit score (720 or higher is typically considered great). They will also need to explain their intended use of the land, which can vary depending on what type of loan they’re interested in. Borrowers must also highlight aspects of the property that need to be checked, like zoning, land-use restrictions, surveyed boundaries and access to utilities. These factors will give lenders an idea of how risky the loan might be.

Once a lender takes these factors into consideration, 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 debt-to-income ratio.

After the loan’s rates are determined and the borrower has been approved by a lender and agreed to the loan’s terms, the borrower is responsible for making a down payment and paying the loan back at the decided interest rate.

Once the construction of your new house is complete, you also have the option to refinance your land loan into a traditional mortgage. Refinancing can help you secure a new principal balance and lower interest rate.  At Rocket Mortgage®, in order to refinance to a traditional loan, your home will need to be fully completed and you must obtain a Certificate of Occupancy.

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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 of these pros and cons and see how they’d apply to your personal needs and financial situation.

Pros

If building a home or business is important to you, there are many benefits of applying for a land loan. The biggest benefit by far is having the opportunity to build the home of your dreams. If you’re looking to use the land for commercial purposes, it can also give businesses the opportunity to capitalize on up-and-coming areas. If you have a vision and are creative and patient, using a land loan to build a home or business would be the perfect option for you.

Cons

It’s important to understand the realities and drawbacks of applying for a land loan. For example, when there isn’t a house that can be used as collateral, a land loan can be riskier for lenders which makes many lenders less willing to loan to borrowers. When it comes to financing, there is also the potential for a higher down payment requirement and higher interest rates. Because it’s a new construction project, there is also the possibility of experiencing unforeseen complications, like failing to complete the construction of the house.

How To Get A Land Loan

If you’d like to get a land loan, it’s typically easiest to do so from a community bank or credit union located near the land you’re looking to buy. But depending on what you intend to use the land for, there can be other loan options available to borrowers. 

For example, if you’re planning to build a primary residence in a rural area, you can apply for USDA loans. USDA loans and USDA construction loans are designed for low- to moderate-income families. They have low interest rates, and depending on the situation, borrowers may qualify for a lot loan with no down payment.

On the other hand, if you’d like to use a land loan for commercial purposes, you can apply for an SBA 504 loan. SBA loans are provided by the U.S. Small Business Administration (SBA) and designed for business owners looking for funds to help contribute to the cost of the land purchase. The interest rates and terms of SBA loans can vary, but the repayment period typically lasts 10 – 25 years.

Other Land Purchasing Options

If you’re interested in purchasing land but are wary of taking out a land loan, consider these other options that might end up being a more suitable choice for your needs.

Home Equity Loan

Home equity loans are different from land loans and may be a more desirable option for some borrowers. They act as a ‘second mortgage’ and allow you to utilize some of the equity you’ve built in your existing home. They don’t require a down payment, and they can usually lock in a lower interest rate regardless of what you plan to do with the land because your home secures the loan. In addition, the interest you pay is not tax-deductible because you’re not using the loan to buy, build or improve the home used as collateral. 

The loan repayment term can vary depending on the lender but could last 5 – 30 years. Unfortunately, if you default on the loan, you could lose your home. Rocket Mortgage does not currently offer home equity loans.

Seller Financing

Seller financing can also be a desirable option for some borrowers. Seller-financed land agreements are sometimes called land contracts. These are real estate agreements where the seller acts as a lender and handles the mortgage process directly instead of a financial institution or lender. Instead of applying for a traditional mortgage, the buyer signs a contract with the seller. 

This option can be beneficial for buyers because sellers tend to be more flexible than financial institutions, which means it might be easier to qualify for a seller-financed loan than a traditional one. Seller financing can be useful for aspiring land buyers who might struggle to qualify for a land loan or afford a large down payment, but there are downsides to this option as well. 

Legal homeownership can be a bit of a gray area when paying for a seller-financed property, because while you will receive equitable title, your seller actually retains legal title of the property until you pay it off, which can cause problems. Additionally, your seller may charge you higher interest rates and the terms of your contract may be vague.

The Bottom Line

If you’d like to build a home, be sure to weigh the benefits and drawbacks of a land loan to see if it’s right for you. While the thought of building your dream home sounds perfect, it’s important to be aware of the realities that come with taking out a land loan or lot loan. 

Luckily, if you’re not interested in obtaining a land loan, there are other options for you. Although Rocket Mortgage does not offer land loans, we may be able to help you refinance an existing land or construction loan to get a traditional mortgage on your newly built house. Learn more about this process by chatting with one of our Mortgage Experts today about your refinancing options or give us a call at (833) 326-6018.

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Emma Tomsich

Emma Tomsich is a student at Marquette University studying Corporate Communications, Marketing and Public Relations. She has a passion for writing, and hopes to one day own her own business. In her free time, Emma likes to travel, shop, run and drink coffee.