Land Loans: How to Get a Loan for Land

Oct 5

What is a Land Loan?

A land loan is a type of loan specifically designed for the purchase of vacant land or undeveloped property. Unlike a mortgage, which is used to finance the purchase of a home or other real estate with existing structures, a land loan is used to finance the acquisition of raw land for future development or investment purposes.

Types of Loans For The Purchase Of Land

There are several types of land loans available to borrowers, each tailored to different purposes and circumstances. The following are common types of land loans.

Lot Loans: Lot loans are designed for the purchase of individual lots within a subdivision or development. Lot loans are typically designed to be absorbed by the construction loans and can be as little as 25% of the lot’s cost. You don’t need to borrow the full amount of the lot either, this can be used to preserve funds for the design phase of the project which will need to be paid upfront.
Home Equity Loans or Lines of Credit (HELOCs): Homeowners with sufficient equity in their primary residence may be able to use a home equity loan or line of credit to finance the purchase of land. These loans allow borrowers to tap into the equity in their home to secure financing for other purposes, such as land acquisition. This type of loan does not count as an encumbrance on the land itself, as the HELOC is on your primary home. Having a HELOC balance can impact your overall financial picture.
Margin Loans: Margin loans offer investors the opportunity to borrow against their existing portfolio to buy additional securities. This strategy can amplify potential returns but also comes with increased risk. By leveraging investments, investors can access larger sums of capital, allowing for more significant market positions and potential gains.
Bridge Loans: Bridge loans are short-term loans used to bridge the gap between the purchase of land and the permanent financing or development of the property. These loans provide temporary funding to cover acquisition costs until a long-term financing solution is secured.
Owner Financing: Owner financing, also known as seller financing, occurs when the seller of the land provides financing directly to the buyer, eliminating the need for a traditional lender. This arrangement can offer flexibility in terms of down payment, interest rate, and repayment terms negotiated between the buyer and seller.
Agricultural Land Loans: Agricultural land loans are used to finance the purchase of farmland for agricultural purposes, such as crop production, livestock grazing, or farming operations. These loans may offer specialized terms and repayment options tailored to the needs of agricultural borrowers. Some government-sponsored loan programs, such as those offered by the U.S. Department of Agriculture (USDA) or the Small Business Administration (SBA), may provide financing options for certain types of land purchases, such as agricultural land or land for small business development.

Land and lot loans are different from construction loans. Construction loans are used to finance the construction of a new home or building on vacant land. These loans typically include funds for construction costs, with disbursements made in stages as the construction progresses. The great thing about construction loans are that they are interested only during the course of construction. Typically, construction loans will absorb the cost of the lot that has been financed.

How Do Land Loans Work?

Land loans work similarly to other types of real estate loans but with some key differences due to the unique characteristics of vacant land. The following items describe how land loans work.

Pre-Approval: borrowers can request pre-approval for a land loan through a lender to determine the amount they can borrow. This is an essential first step, as understanding financing constraints is crucial before looking at land. Pre-approval helps borrowers understand the process and required contingencies to include in the purchase offer. For example, lenders typically require 30 days to process a land loan, so it's important to ensure your financing contingency matches this timeframe.
Application and Approval: Borrowers apply for a land loan through a lender, such as a bank, credit union, or specialized land lender. The application process involves providing personal and financial information, including credit history, income, assets, and details about the land being purchased.
Down Payment: Land loans typically require a larger down payment compared to traditional mortgages. Lenders may require down payments ranging from 25% to 50% of the land's purchase price, depending on factors such as the borrower's creditworthiness, the loan amount, and the lender's policies.
Loan Terms: Land loans may have shorter loan terms compared to mortgages. The repayment period can range from a few years to around 15 years, although longer terms may be available for larger loan amounts or more substantial projects. Interest rates for land loans are typically higher than those for mortgages due to the perceived risk associated with vacant land.
Collateral: The land itself serves as collateral for the loan. If the borrower defaults on the loan, the lender may foreclose on the land to recover the investment. Since vacant land has less intrinsic value compared to improved property, lenders may require a larger down payment and charge higher interest rates to mitigate their risk.
Loan Purpose Restrictions: Some lenders may impose restrictions on the use of funds from land loans. For example, the loan may be designated for the purchase of residential, agricultural, or commercial land, depending on the lender's policies and the borrower's intentions for the property.
Loan-to-Value Ratio (LTV): Lenders may offer lower LTV ratios for land loans compared to mortgages. This means borrowers may need to provide a larger down payment, often ranging from 20% to 50% of the land's purchase price, to secure financing.
Interest Rates: Interest rates for land loans are typically higher than those for traditional mortgages, but usually not too much. Lenders perceive land loans as riskier investments due to the lack of income-generating structures and potential difficulties in reselling undeveloped land.
Repayment: Borrowers make regular payments to the lender, typically on a monthly basis, to repay the principal amount borrowed plus interest. The loan agreement specifies the repayment schedule, including the frequency of payments, interest rate, and total loan term. Also, a lender may want repayment prior to the construction loan, which is a typical process where the lot loan is absorbed by the construction loan.
Due Diligence: Before approving a land loan, lenders conduct their own due diligence, that is different than Buildable’s due diligence (Land Report) to assess the property's value, marketability, and suitability for financing. This may involve appraisals, title searches, and other investigations to evaluate the risks associated with the land. It is an absolute must that you conduct your own due diligence on the property, as they are not looking into buildability – just that the lot is worth what they are borrowing.
Closing: Once the loan is approved, the borrower and lender finalize the transaction through a closing process similar to that of a traditional real estate transaction. The borrower signs the loan documents, pays any closing costs or fees, and takes ownership of the land subject to the terms of the loan agreement.

Pros & Cons of Land Loans

We recommend purchasing the lot outright, as it can serve as valuable collateral for your construction loan. By doing so, you may not need to contribute additional cash towards the loan, streamlining the financing process and potentially lowering your overall costs.

Land loans offer both advantages and disadvantages for borrowers, depending on their financial goals and circumstances. Lot loans provide flexibility for buyers and investors to acquire vacant land for various purposes, such as development, investment, or personal use, without the restrictions of traditional mortgages. Furthermore, land loans can be used to diversify investment portfolios and access opportunities in real estate markets.

However, land loans also have drawbacks. They typically require larger down payments and higher interest rates compared to mortgages, increasing the upfront costs and overall financing expenses for borrowers. Additionally, land loans may have shorter loan terms and stricter eligibility requirements, limiting borrowers' options and flexibility compared to traditional mortgages. Overall, while land loans offer opportunities for investors to acquire undeveloped properties, they also come with higher costs and risks that borrowers should carefully consider before pursuing financing.

How to Get a Land Loan

The following steps describe the process to getting a land loan.

Prepare Financial Documentation: Before applying for a land loan, gather the necessary financial documentation, including proof of income, employment history, tax returns, bank statements, and other relevant financial records. Lenders will use this information to evaluate your creditworthiness and ability to repay the loan.
Research Lenders: Research lenders that offer land loans and compare their terms, interest rates, fees, and requirements. Consider factors such as the lender's reputation, customer service, and experience with land financing. Choose a lender that best suits your needs and financial goals.
Complete the Pre-Approval for a lot loan: Once you've selected a lender, complete the loan pre-approval application form provided by the lender. Provide accurate and complete information about yourself, including personal details, financial information, employment history, and details about the land you intend to purchase to make sure you don’t run into issues further down the line.
Complete the Loan Application: Once you are in escrow for the lot and you've selected a lender, complete the loan application form provided by the lender. Provide accurate and complete information about yourself, including personal details, financial information, employment history, and details about the land you intend to purchase.
Provide Documentation: Submit the required documentation along with your loan application. This may include copies of your ID, income verification documents, tax returns, bank statements, and any other documents requested by the lender. Be prepared to provide additional information or clarification as needed during the application process.
Underwriting and Approval: After receiving your loan application and supporting documentation, the lender will review your financial profile, credit history, and the property's details to assess your eligibility for the loan. This process, known as underwriting, involves evaluating the risks associated with the loan and determining whether to approve or deny your application.
Property Evaluation: As part of the underwriting process, the lender will evaluate the property you intend to purchase to assess its value, marketability, and suitability for financing. This may involve ordering appraisals, title searches, surveys, environmental assessments, and other due diligence measures to verify the property's condition and ownership status.
Loan Offer and Terms: If your loan application is approved, the lender will provide you with a loan offer outlining the terms and conditions of the loan, including the loan amount, interest rate, repayment schedule, fees, and any other relevant terms. Review the loan offer carefully and make sure you understand all the terms before accepting the loan.
Closing: Once you've accepted the loan offer, the lender will proceed to the closing stage, where you'll sign the loan documents and finalize the transaction. During the closing process, you'll pay any closing costs, fees, or down payments required by the lender, and take ownership of the land subject to the terms of the loan agreement.
Loan Disbursement: After closing is complete, the lender will disburse the loan funds to the seller or designated party, and you'll officially become the owner of the land. Make sure to adhere to the terms of the loan agreement and make timely payments according to the repayment schedule to avoid defaulting on the loan.

Why Are Land Loans Hard to Get?

Land loans are typically easy to get in San Diego. Unlike traditional mortgages, which are secured by homes or buildings that have intrinsic value and can generate income, land loans rely solely on the value of the land itself.

Lenders may also impose stricter eligibility criteria, such as higher credit score requirements and lower loan-to-value ratios, to minimize their exposure to risk. Moreover, the lack of infrastructure, utilities, and development plans for vacant land can further complicate the lending process, as lenders must assess the property's potential for future development and marketability. Overall, the inherent risk and unique characteristics of land investments make land loans harder to qualify for compared to traditional mortgages.

How Buildable Can Help You Find Land for a Custom Home

At Buildable, we specialize in demystifying the complex and often opaque process of land development in San Diego, CA. Our mission is to guide our clients smoothly through their projects, helping to avoid common pitfalls while saving both time and money. From the outset, Buildable takes the lead, leveraging our network of reliable partners to ensure your project is not only completed within budget but also meets your timeline. From helping you find land to the final inspection, Buildable is your one stop shop for custom home builds. To learn more about how we can assist you and to discuss your specific project needs, schedule a consultation with us here.