Lot Loans: Everything You Need To Know
Updated: Aug 3
Buying a home is an exciting step in our lives. We’ve all imagined how we’ll arrange the furniture in the living room or have envisioned ourselves reading a book on the porch when looking at homes. But, sometimes every house you look at just doesn’t click with your vision.
Potential home buyers might decide to construct their new home themselves so they can customize it. Also, it’s a pretty cool feeling to get your hands dirty and know that you built your home from the ground up. But, building your perfect home can be an expensive goal, and you won’t be able to take out an ordinary mortgage to finance the land you build on.
This is why lot loans are excellent resources for future homebuilders.
What’s A Lot Loan?
Lot loans, also called land loans, are used for financing the purchase of a plot of land that doesn’t have a home/structure built on it. So, people who take out a land loan are typically driven by their desire to construct their new house. But, in some cases, they might utilize the land to grow their business.
Know Your Land Type
Before you take out a loan for a piece of land, you need to understand what type of land you’re working with. Technically, not all land constitutes a “lot.” The three main types of land available for purchase are improved, raw, and unimproved.
Is It Improved Land?
When the lot of land is finished (meaning it’s well-equipped for residential development), it qualifies as improved land. It’s prepared for the addition of residential properties; and as a result, generally includes some or all of the following features:
A building permit or appropriate zoning
A report marking the site’s boundaries
Water supply and electricity on site or nearby
Access to public roads or a permanent easement to gain access to public roads
Access to public sewer or viable alternative
Taking out a lot loan for improved land is usually more expensive since it’s the most developed type, which makes it the least risky for lenders. Thus, improved land loan interest rates and down payments are usually lower than other types of land loans.
Is It Raw Land?
A vacant parcel of land that’s completely undeveloped is called raw land. In most cases, it has no access to roads, water, or electricity; and in turn, it may or may not be suitable for residential development.
This type of land loan will usually have a high interest rate and require a large down payment. Even though the price of raw land is almost always cheaper than if it were developed or unimproved, it can still be tough to get financing for it.
Is It Unimproved Land?
Unimproved land falls in between improved land and raw land because it may have some amenities or utilities but may not have a phone box or an electric meter. This makes it slightly more developed than raw land but not developed enough to qualify as improved.
Just as unimproved land falls in between raw land and improved land, an unimproved land loan also falls somewhere in the middle. Likewise, the interest rates and down payments will likely be higher than raw land loans but lower than improved land loans.
Is A Lot Loan What You Need?
Residential land loans are a suitable choice for those who have a plan to build their future home but can’t get started on the construction immediately. So, if there are circumstances that may delay your building process by a year or longer, a land loan is a good choice for you.
However, if you want to start building on your purchased tract of land immediately, you’ll need a construction loan. This is because construction loans are short-term and intended for prospective builders who have a specific plan for their process and want to get started right away.
Consider The Pros And Cons
All lot loans come with a few general benefits and drawbacks. The biggest benefit of getting one is that it allows you to build a house exactly the way you envision it. So, if you’re creative, patient, and in the right place financially, a land loan can be a terrific option for you.
On the other hand, land loans and high-interest rates typically go hand in hand. A land loan down payment can also take out a big chunk of your savings. Thus, you may find yourself tapping into your home equity, which can put your current home in jeopardy.
Another drawback is that you may have to take extra steps or jump through some hoops to get a land loan.
Why Lot Loans Can Be Tough To Get Without The Right Lender
Land isn’t as in demand as homes, which is why land loans take up a pretty thin slice of the lending market and aren’t as common as mortgage loans. So, there aren’t many options presented to borrowers who seek a land loan. Likewise, these loans are risky for lenders to give out because land can be tough to sell if a borrower defaults.
In most cases, land doesn’t generate any income. Meaning if you don’t live on it, you’ve got nothing to lose other than the actual piece of land. This is why most people don’t sweat over walking away from a land loan if they get into financial trouble.
When you’re in a financial bind, you likely prioritize making your rent or car payments on time because you know if you don’t, you’ll lose your home or mode of transportation. Now, with a land loan, you may not be as motivated to make your monthly payments since losing a piece of land won’t render you homeless.
This is why lenders might want to cross-collateralize other property that you own as additional security for your land loan. They also may require you to have banking deposits or other liquid financial assets at their bank. This gives them more of a cushion if you default.
The best deal you’ll get for a lot loan will most likely be from a lender in your community. They have a keen understanding of the local market and are usually more committed to lending on local property. At Northport, we offer land loans for raw land, unimproved land, and improved land.
Process For Borrowing A Land Loan
To get a lot loan, the process isn’t that different from applying for a mortgage loan. You’ll need to give information about your income, employment, debt, and assets; and complete the appropriate application. But, you might also need to provide a statement of intent for how you’ll use the land. This gives the lender an idea of what the future value of the land will be worth.
Financing A Lot Loan
Because interest rates and down payments for land loans typically run higher than for mortgage loans, financing can be difficult. However, there are many options available to help you get a land loan. A common way is using a combination of three loans.
The Three Loan Option
This is a pretty standard route to take for future homebuilders. There are three loans for land purchase and house construction that you can use together.
The first one is the land loan which buys the plot of land. The second is a construction loan which pays off the land loan and pays for the building of the home. And the third is the “final” or “permanent” loan that pays off the construction loan.
Build Your Dream Home
Getting a land loan to buy land and build a house is a great resource for first-time homebuilders. With the right plan for your situation, securing a land loan is an excellent way to support the construction of your new house.