Conventional financing is the most common type of financing borrowers try to obtain, however, if you wish to buy land, it might not be the best choice. Many lenders do not offer conventional options for a land purchase. This is because purchasing land does not offer the same type of collateral as a home does. This puts the lender at a much higher risk for default. The lender considers many factors to determine your eligibility for a land purchase, otherwise known as a lot loan.
What are Your Plans for the Land?
The most important thing a lender considers is how you will use the land. Will it just sit empty for a long time or do you have immediate plans for it? Are you building a home or a commercial building? These answers all play a role in the type of financing you can receive. If you have immediate plans to build a home, you might be eligible for a construction loan, which provides the money to purchase the land as well as build the home. After construction is complete, the loan flips over into a standard fixed rate loan, giving you the best of both worlds.
What Does the Lender Need to See?
The lender looks at different aspects of the land to determine if they want to loan you the money to purchase it. The main component is the access to the land – is there direct access? If not, chances are no lender will provide funding. What is the zoning in the area and does it coincide with your plans? For example, if you plan to build a home, but the zoning is commercial, you will not be able to follow through with your plans. This is a detail the bank needs to know.
Conventional Loans are a Long Shot
It is a very rare circumstance to find a conventional lender who will provide money to buy land. The risk is too high for the lender because it is very easy to walk away from land as opposed to a home. Because you do not live on the land, you likely have other housing arrangements. If you cannot afford the terms on the land loan, you can walk away without losing your place of residence. This is the largest factor which affects the decision of conventional lenders.
What are Your Options to Buy Land?
Just because conventional lenders will not provide funding to buy land does not mean you cannot find it elsewhere. There are several options for you to consider:
- Seller financing – This is one of the most common scenarios and it does not involve a bank. The person selling the land may be able to provide you with the financing. They set the terms of the loan and the payments. The more money you have to put down on the land, the better off you will be when it comes to the terms of the loan. Typically, the seller wants to make his money back fast, so it will be a shorter term than a standard mortgage, but it can help you make the purchase you want.
- Home equity loan – If you currently own a home and you have equity in it, you might be able to tap into the equity to purchase the land. You will have to take out either a cash-out first mortgage or a second loan, which is a home equity line of credit. Either way, you end up with the cash in your hand to purchase the land with cash. This way there is no financing on the land; it is only on your current home. Because your home serves as collateral, many lenders are more willing to offer this option.
Land Purchases Require Large Down Payments
Whether you end up securing financing from the seller or a lender, you will need a large down payment. If you thought 20% was a lot to put down on a home, you are in for a big surprise regarding the purchase of land. It is not unusual to find lenders who require a 50% down payment on the purchase of land. This is because there is no collateral for them to hold on to if you were to default. The down payment is usually the highest when you do not have any immediate plans for the land. The longer it sits idle, the greater the risk for default.
Just because conventional financing might not work to help you buy land does not mean there are no other options. You have to be willing to think outside of the box. Start by looking at your current home and the amount of equity you hold in it. If you can tap into the equity, this is the best place to start. If you do not have equity or you are not eligible to take it out, then you can look at your other options including seller financing or securing funding directly from a lender. Just as with home financing, make sure your credit and finances are as attractive as possible in order to obtain the best terms for your loan.