Here’s what you need to know about land loans as an investor.
If you’re thinking of investing in land and need to finance the purchase, it doesn’t make sense to apply for a traditional home loan. In this case, you’ll need to apply for a land loan, and the process is likely different than what you might expect.
With that in mind, here’s a real estate investing guide to land loans. We will cover what a land loan is, the different types of land loans available, and what you should know about applying for this type of real estate financing. Read it to determine if getting a land loan is right for you.
What is a land loan?
As the name suggests, a land loan is used to finance a tract of land. Put simply, if you want to buy a plot of land, you wouldn’t use a traditional mortgage to finance the purchase; you’d use a land loan instead. However, since there’s less interest in buying undeveloped pieces of land, these loans are less common than most other types of financing.
Though not always the case, sometimes investors will use this type of loan to facilitate a land purchase, intending on developing the land for a residential or commercial purpose later on. Often, these loans are more common in rural areas where land is more likely to sit undeveloped for a longer period of time.
Types of land loans
In total, there are three different types of land loans. If you’re thinking of obtaining financing for a land purchase, be sure to ask your lender if they have experience with the type of loan you think best suits your needs.
Raw land loan
As you might be able to guess from the name, a raw land loan is used to finance the purchase of completely undeveloped land. You’ll use this type of loan if you’re interested in purchasing bare land, meaning no electricity, sewer, or roads connected to the property.
This is often the most difficult type of land loan for which to receive approval. Since the land is totally undeveloped, it presents the biggest risk for the lender. So if you’re going after a raw land loan, make sure you have a cohesive plan for how you intend to use the raw land. The more details you can provide the lender, the better.
Unimproved land loan
Unimproved land is similar to raw land, except it tends to be slightly more developed. For example, a piece of unimproved land might have access to electricity and gas lines but lack the meters and equipment necessary to actually use these utilities.
Since unimproved land tends to be more developed than raw land, it also tends to be more expensive. But that means it may be easier to qualify for an unimproved land loan, since the lender may view the lot as less of a risk.
Improved land loan
Finally, there’s an improved land loan. Improved land typically already has access to things like roads and utilities. Again, while this likely will be the easiest type of land loan to be approved for, it also will be the most expensive because the land is the most developed.
Land loans: pros and cons
Investors, especially new ones, tend to wonder what the advantages are of getting a land loan over something like a construction-to-permanent loan, which lets you roll your costs for buying and building into one mortgage payment. But there are a few benefits to going after a land loan. Read them to see if a land loan might be the right choice for you.
Pros of land loans
Freedom to find the best use
One of the biggest benefits of choosing a vacant land loan for your financing is you have the option of choosing the best use for the property and shaping the land however you see fit.
The caveat is that you may be limited by existing zoning restrictions. if you decide to go this route, do your homework and talk to someone on the local zoning board and planning commission to see if your vision can become a reality.
More affordable than developed land
As stated above, undeveloped land is generally considered more affordable than developed land. Getting a piece of undeveloped land in an up-and-coming area can be a good investment strategy. However, a land loan usually only represents part of your total cost. Generally, investors will also have a construction loan to worry about after they purchase the land itself.
Cons of land loans
Those points aside, there are also some disadvantages to getting a land loan over a construction loan. Be sure to consider these carefully to know what you’re getting into if you do end up pursuing this type of financing.
You may face stricter qualifying requirements
Since land loans are often thought to be riskier by lenders, they also come with stricter qualifying requirements. You likely need to have a good or excellent credit score, and you should be prepared to put down a larger-than-normal down payment. Additionally, you may be subject to a higher interest rate.
The tax benefits are limited
Unfortunately, the tax benefits of buying land are limited. While you may be able to depreciate certain improvements, such as roads or a sewer system, you won’t be able to take a mortgage interest deduction until you’ve built a structure on the land and construction is complete.
No immediate cash flow
As an investor, there’s not going to be any immediate cash flow with this property. In fact, you have to build your structure on the lot before you see any substantial income from your investment. In the meantime, you also have to worry about paying property taxes, as well as financing the improvement costs.
How to get a land loan
Finally, now that you’re familiar with the advantages and disadvantages of getting a land loan, learn how to get a land loan as an investor. While land loans are often trickier to procure than traditional mortgages, it’s not impossible. To that end, below are four options for securing financing.
Consider owner financing
In an owner financing scenario, instead of getting financing from an institutional bank or lender, you’ll make a financing agreement directly with the seller. Over time, you’ll make payments to the seller in exchange for equity.
That said, this type of arrangement may be more difficult to find. Many sellers aren’t interested in acting as a bank or having to sell a mortgage note on the secondary market to receive a payoff.
Find a local bank or credit union
When you’re looking for a land loan, choose a lender who specializes in land financing. For that, you may want to go to a local bank or credit union in the area where you intend to buy. Often, local institutions will be more experienced with land transactions, and they may also offer more flexible terms for loan approval than a national institution.
Get a USDA loan
If you’re planning on buying rural land and want to develop multifamily housing available to low-income individuals, you may be eligible for a USDA loan. These loans often offer a competitive interest rate, as well as a 30-year loan term, uncommon with land loans.
However, you have to build an eligible rural area and may face a more complicated loan process, which likely includes meeting various state and local requirements.
Use a home equity loan
If you already own your own home, another option is to use a home equity loan to purchase the land. In this case, a home equity loan will act as a second mortgage. You’ll receive the money in one lump sum and will be expected to make regular payments on both the principal and interest of any amount you’ve borrowed.
The Xpress Loans 911 bottom line
Getting a land loan might be a little more complicated than getting a traditional home loan, but it can be done. If you do your homework and come up with a plan for how you intend to use the land, you should be a solid borrower, provided your financial profile is also above average. To that end, use this guide to help start your research. Armed with this knowledge, you should have a better idea of what type of land loan is right for you.
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