What to know about land loans.

Everything You Need to Know About Land Loans

by SouthStar BankMay 15, 20240 comment

Thinking about building a custom home? If you can’t find the house of your dreams, building your home can be ideal.

All you have to do is finance the process.

Fortunately, you don’t have to have a pile of money in the bank to do just that. Instead, you can take out a land loan.

Land Loan: What is it?

A land loan, also known as a lot loan, is used to fund the acquisition of a piece of land. If you’re interested in purchasing land on which to build a house or other structure, you can get a land loan. The type of loan you choose will depend on where you want to acquire land and how you’ll use it.

Land or lot loans are also a preferable option for potential home builders who have a concept but who might not want to start building and financing a house immediately. If you are worried that your construction has to be delayed or if you’re still finalizing your home plans, then a land loan is probably the best option for you.

How Do Land Loans Work?

You’ll typically need a down payment of at least 25% to take out a land loan.

You’ll need a credit score of 720 or higher to take out a land loan. You may also need to provide your lender with information about how you intend to use the land. This often means conducting due diligence in regard to the property’s existing zoning, land-use limitations, surveyed boundaries, and existing utility access.

This information will help lenders assess the potential risk of the loan.

Lenders adjust interest rates in response to these factors, but regardless, you should expect higher interest rates than you’d see from a traditional mortgage. This is because a land loan is riskier for the lender than a mortgage.

However, if a borrower has superior credit and a lower debt-to-income ratio, they may be eligible for lower rates.

Once the borrower has been approved by a lender and accepted the loan’s terms, they will be responsible for making a down payment and repaying the loan at the decided interest rate.

In addition, land loans typically have shorter repayment terms than traditional home loans. Terms typically range from 12 months to 3 years.

Another option for borrowers, is to convert the land loan into a conventional mortgage after the building of your new home is finished. This will allow them the chance to get a fresh principal balance and a cheaper interest rate through refinancing.

Converting Loans

A land loan lets you secure a piece of land until you’re ready to build. You’ll only have to pay for the costs of holding the land itself.

When you’re ready to start building, you’ll want to convert the land loan to a construction loan. This loan is a 12 to 18 month loan. Your land loan will roll into your construction loan, and the down payment you used on your land loan will be applied to your construction loan.

Your lender then distributes the funds in a series of draws as you complete each phase of your construction process. The money gets paid directly to your builder after a completed inspection.

Once the house is built, you can convert the construction loan into a traditional home mortgage loan. You might also opt for a construction to permanent loan which completes this option automatically.