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A land loan, also sometimes called a lot loan, is a specialized form of financing that you can use to buy land, either for residential or commercial purposes. They're particularly worth considering if you don't plan on building right away on the property and, therefore, don't qualify for a construction loan.
If you're thinking about buying land in the near future, here's what you need to know about land loans and whether it's a good idea to use one.
What Is a Land Loan?
A land loan is similar to a traditional mortgage loan, but instead of buying a finished home, you're purchasing a plot of raw, unimproved or improved land. You'll typically receive the money upfront to buy the land, then pay back the loan over two to 20 years, depending on the lender and loan details.
In some cases, you may have a balloon payment to make at the end of your repayment term, in which case you'll need to have that money on hand or have a plan to build a property on the lot so you can use a construction loan to pay off the land loan.
There are a few different types of land loans you may come across, depending on the type of lot you're looking to buy:
- Raw land loan: With this type of loan, you're buying land that doesn't have any developments or amenities, such as sewer, water, electricity or even roads.
- Unimproved land loan: Unimproved land doesn't have all of the amenities required to be fully developed, but it may include some basic development, such as road access or electricity.
- Improved land loan: With this type of loan, you can buy a plot of land that has all of the necessary amenities to build a home, business or other structure. For example, you can find improved land in a subdivision that a developer has improved for the purpose of selling off individual lots.
Because there's no structure to use as collateral, land loans tend to be riskier than traditional mortgage loans, so expect more stringent eligibility criteria and higher interest rates compared to a home loan.
Finally, the less improved the land is, the more expensive getting a loan will be because it presents more of a risk to the lender in the event that you stop making payments.
What Are the Requirements for a Land Loan?
As with traditional mortgage loans and construction loans, the eligibility requirements can vary from lender to lender. With that said, here are some general minimum requirements you may see:
- Credit score: Upper 600s to lower 700s
- Down payment: Up to 50%
- Debt-to-income ratio (DTI): 43% or less
Also, note that you'll typically need to have a plan in place for what you want to do with the land. If you don't have a clear plan for development to share with lenders, particularly with less developed lots, you may have a hard time getting approved.
In general, you can expect an interest rate of around 7% or higher, with your rate depending on your creditworthiness, loan terms and type of land.
Is a Land Loan a Good Idea?
A land loan can be a good idea in certain circumstances, but it's important to understand both the benefits and drawbacks before you make a decision. It's also a good idea to compare potential alternatives, such as using a home equity loan or line of credit secured by your current property or a personal loan.
Here are some pros and cons to consider.
- Gives you time: Unlike a construction loan, a land loan doesn't require that you start building immediately.
- Provides flexibility: Instead of buying an existing home or business, using a land loan to buy a plot of land gives you the opportunity to develop the property exactly as you want.
- Can be cheaper than some options: If you're comparing a secured land loan with a personal loan, you may be able to get a lower interest rate and longer repayment terms.
- Can be expensive: Compared to traditional home loans and construction loans, land loans can be expensive in terms of interest rates and down payment requirements. This is especially true with less developed lots.
- Realizing your dream can be challenging: You may run into issues with permits, surveys and other processes to realize your dream of building the home or business of your dreams. If you run into complications, you may not be able to use the land in the way you want. If you decide to abandon your goal, it can be difficult to sell the land.
- Harder to get: It's harder to find lenders that offer land loans compared to traditional home loans, and you'll also face more strict approval requirements.
Evaluate Your Options and Your Credit Before Applying for a Land Loan
Before you apply for a land loan, or any type of loan for that matter, it's important to research all of your options. Depending on the cost of the lot you hope to buy, you may be able to get it with straight cash or apply for a home equity loan, HELOC or personal loan. If it's a more expensive plot of land, however, your options may be more limited.
Regardless of how you decide to finance your purchase, review your credit score and credit report to determine your chances of getting approved with favorable terms. If your credit file needs some work, don't hesitate to take some time to improve your credit before you get started. Additionally, take your time to shop around and compare offers from multiple lenders. That way, you can make sure that you get the best deal available to you.