How Do You Get a Land Loan?

“Buy land, they’re not making it anymore.”

– Mark Twain

Maybe you’re considering purchasing empty land as an investment – especially if it’s located in an area you predict will become more developed in time. Or perhaps you would like a vacant lot because you’re the only one who is qualified to build your dream home.

Either way, unless you have the free capital to cover the entirety of your desired land’s purchase price, you will likely have to apply for a land loan.

A land loan comes with several benefits. Undeveloped land is often more affordable than the alternative. You’ll also have total control over how you shape your land and what you use it for (zoning restrictions notwithstanding).

Take care, however, as land loans do come with downsides. Lenders perceive them as riskier due to their inherent lack of collateral. They’ll assign higher down payments and interest rates accordingly. If you’re buying undeveloped land as an investment or for cash-flow purposes, your return on investment is probably a long way off. Furthermore, even the most experienced builder knows that development always carries the risk of unforeseen (and expensive) problems.

Those caveats aside, if you have committed to buying land you can’t pay for out of pocket, a land loan is your best bet!

What Kinds of Land Loans Are There?

Sometimes referred to as a “lot loan,” a land loan is exclusively used to purchase empty land. This can be for residential or business purposes. Borrowers often apply for land loans when they don’t intend to begin construction immediately. Land loans don’t come with conditions dictating when construction must commence or finish.

Three types of land loans are commonly awarded:

1. Raw land loan

This loan applies to land that is currently in its totally natural condition – no electricity, roads, or any other evidence of civilization. Lenders may be cautious about granting a raw land loan unless the borrower demonstrates they possess the means and experience necessary to do something productive with virgin land. Raw land is typically the cheapest. Loans for it require larger down payments and carry the highest interest rates.

2. Unimproved land loan

This loan applies to land that has already been developed to some degree. While unimproved land often has access to some utilities, it lacks the meters and other mechanical units necessary to utilize them. Lenders generally perceive unimproved land loans as less risky than raw land loans. They do still require significant down payments and high-interest rates.

3. Improved land loan

This loan applies to land that is ready for development, with road access and all utilities in place. Because improved land requires little preparation before construction can commence, it usually costs relatively more. Its higher purchase price is offset by lenders’ lower down payment and interest requirements.

It is important not to confuse a land loan with a construction loan. The latter refers to a type of loan which covers the costs of building a new home or another type of real estate. A construction loan is effective during a shorter term. It requires that construction conclude within a set period of time. They also can carry a higher interest rate until transferring over into a more conventional fixed-rate mortgage.

What Do You Need to Apply for a Land Loan?

As explained above, because each type of land loan is associated with varying levels of risk, each comes with its own requirements. That said, a borrower typically must do three things in order to receive a land loan:

1. Make a down payment. Improved land loan down payments are often as low as 20% of the land’s purchase price. Unimproved and raw land loan down payments are typically higher at 35.

2. Have a good credit score. Many lenders require a borrower to possess a higher credit score before they award them a land loan.

3. Have a plan for the land. Lenders are more likely to award a land loan if the borrower has a clear and intended use for the lot. Borrowers who already have plans in place to build a home or business, or a reasonable expectation for the land to appreciate in value without development, have a strong advantage. Borrowers who can demonstrate their knowledge of utility access, zoning laws, and other relevant restrictions will benefit from an even stronger advantage.

As with other types of loans, it is possible to arrange a land loan with owner financing. Sellers willing to take on that degree of risk are rare, however, so you will probably get better results by partnering with an institutional lender.