The Home Buyer’s Guide to Land Loans

Land loans, commonly referred to as “lot loans,” are precisely what their name implies. They let you borrow to purchase a parcel of land for future development.

Naturally, they’re similar to mainstream residential mortgages in concept. But there are key differentiators that set land loans apart, which we’ll lay out in detail below.

In this article (Skip to...)

• What are land loans?
• How does a loan loan work?
• Types of land loans
• Pros and cons of land loans
• Who offers land loans?
• The bottom line

What are land loans?

A land loan is a type of mortgage you use to buy a tract, lot or parcel of land that doesn’t already have a residence. You can then build a home on it either immediately or sometime in the future.

However, if you plan to develop your parcel immediately, you may be better off with a construction loan. This all-in-one mortgage funds buying the land and building the home.

There are three main types of land loans. They are:

Standard retail land loans

Under this category, you apply to several banks and mortgage lenders that extend these loans. And you find the most favorable deal among the offers.

Those lenders are likely to expect high standards of creditworthiness from you. And they’ll require evidence that you can comfortably afford the loan payments after meeting your existing debt obligations. They’ll also check that you have a dependable source of income.

But they’ll likely still charge you comparatively higher interest rate and fees, require a more significant down payment, and offer you a shorter term than they would on a standard residential mortgage.

How come? When hard times hit, people are much more likely to walk away from an undeveloped parcel of land than they are their own home. So the lender’s risk is higher.

Seller financing

Sometimes, the land’s current owner can be willing to finance your purchase. This would be an unregulated, purely private arrangement conducted between you and the seller with no pre-set thresholds for credit scores, affordability, down payment, income sustainability and so on.

However, despite any regulatory involvement, a smart seller will still want to check all those factors out. And they should set the down payment and mortgage rate accordingly.

Home equity borrowing

If you’re a homeowner with significant equity in your home, you can probably borrow using that equity as security. (Equity is the surplus value of your home in relation to your outstanding mortgage balance.)

Home equity products can be more affordable than land loans because your existing home secures the borrowing, not an undeveloped lot. And they’re typically easier to get approved for.

A home equity loan gives you a lump sum, which you repay in equal installments over a period you largely choose. That could be ideal if you plan to develop the lot after some years. By then, you could own the land outright and borrow just for the development.

A home equity line of credit (HELOC) is more flexible. At least for the first few years, you can borrow up to your credit limit and make monthly payments that solely cover the interest due. So, this could be a less expensive way of borrowing in the short term. For example, if you plan to develop the land within a few years.

How does a land loan work?

So, there are various options when you want to finance the purchase of a parcel of land. But let’s assume you wish to explore land loans further.

Applying for one of these is very similar to applying for a standard residential mortgage. However, they’re less widely available than typical home loans. And you’ll have to seek out candidate lenders.

Some experts recommend shopping locally. In other words, try to find a lender that’s located close to the land you wish to buy. And try community banks and credit unions first.

If possible, get multiple quotes. Just like with mainstream mortgages, there are vast disparities between the terms you may be offered by each lender. And you want the best you can get.

The U.S. Department of Agriculture (USDA) does offer land loans. But these are primarily available to private or public non-profit organizations. You could check whether a friendly one operates in the relevant area but you may have to sacrifice some of your control over the project.

Qualifications

As we mentioned earlier, getting land loans is typically tougher than regular mortgages. In October 2022, Experian, one of the leading credit bureaus, suggested the borrower qualifications you may need. It said you’ll likely want a:

1. A credit score in the high 600s or low 700s
2. A debt-to-income ratio at or below 43%
3. A down payment of up to 50% of the land’s purchase price, depending on the land type and your circumstances

In addition, you’ll probably have to pay a higher mortgage rate than the prevailing one for standard home loans at the time you apply. And you almost certainly won’t be offered a 30-year loan. Much shorter ones are normal.

You can see why those with plenty of equity in their existing homes might find it easier and less costly to tap that rather than opt for a land loan.

What are the different types of land loans?

There are different types of land loans. But it’s the land rather than the loan that determines the differences.

In other words, your loan is likely to be more costly and difficult to get as the land you want becomes increasingly challenging to develop. Here are the three land types, starting from the most straightforward to the most challenging to develop.

1. Improved land loan

This designation pertains to land primed for immediate use. You already have road access. And water, electricity, phone and perhaps natural gas connections are on hand.

This will typically cost you more than other categories of land. But you may find your land loan has a lower interest rate, a smaller down payment minimum, and is easier to qualify for compared to other land loans.

Still, be prepared to pay the price. Your new loan remains likely to have a higher interest rate, down payment requirement and qualifying hurdles than a mainstream residential mortgage.

2. Unimproved land loan

Unimproved land typically has fewer utility connections and amenities on hand. Consequently, you may incur expenses to install them or to provide alternatives (solar power or generators; a well, a septic tank, etc.) upon parcel development.

That adds to the lender’s risk of the project being unviable. So, expect higher costs and stricter qualifying criteria than with an improved land loan. You may need at least a 20% down payment, perhaps more, and a a more robust credit score.

3. Raw land loan

This category involves purchasing a plot without any utility connections or road access. Therefore, developing your parcel is going to be a substantial investment.

That makes your project the least attractive to lenders. To improve your approval chances, you’ll need a viable and costed development plan, a high credit score, and a chunky down payment. Expect to still pay a higher mortgage rate than with improved and unimproved land.

Pros and cons of land loans

Pros

1. You get what you want — This is your chance to design and build the home of your dreams on the lot of your dreams
2. No time pressures — If you get a construction loan, you need to begin project work immediately. With a land loan, you can take your sweet time: months, years, or even decades. Project commencement is totally up to you.
3. Can be less costly than some options — A personal loan will typically cost you more. However, home equity products might cost you less. Explore quotes to know where you stand

It’s all about having the time to refine and fulfill your vision.

Cons

1. More expensive than construction loans and mainstream mortgages. Often more costly than home equity loans and HELOCs
2. Difficult to get — You’ll need to find a willing lender and prove that you’re highly creditworthy and can comfortably afford the loan’s monthly payments. Expect to come up with a significant down payment
3. You’re getting into a construction project — Don’t underestimate the challenges of building your own home. You may encounter zoning or permitting issues, demanding building inspectors, or wayward contractors. The potential obstacles are endless. And how easily will you sell the land if your project stalls?

You need deep pockets, sound finances, determination and patience.

Who offers land loans?

If you do a web search for “lenders of land loans,” you’ll find countless (well, about 172,000,000 at our last attempt) results. But probably only a few of them will pan out.

By all means, apply to some reputable ones. You might get lucky and find your cheapest quote that way.

But, as we said earlier, credit unions and community banks based near your land parcel are often the best sources for land loans. Although national banks and mortgage lenders offering such loans are limited, it’s worth exploring these avenues.

Conclusion

Land loans occupy a prominent niche among financing choices. For some borrowers, they’re ideal.

Perhaps you’re looking for a place to retire in the 2030s. You might own the land outright by the time you reach the construction phase.

And, if you don’t act now, that ideal parcel might well have been developed by the time you wish to build. Of course, if your plans change, you may be able to sell your parcel with a handsome profit, providing it’s the sort of land other people want.

But some other borrowers won’t want a land loan. They might wish to begin their project right away, in which case a construction loan may be more fitting. Or they may find a home equity product less costly.

Whichever sort of financing you want for the land you have your eye on, act quickly. You don’t want to risk losing it to someone else who moves faster than you.