Buying land without a house on it has different requirements for the approval process. A land mortgage is riskier for lenders for a variety of reasons. Here we discuss the requirements for qualification and how to get through the approval process.
Why Loan Loans are Risky
Lenders prefer it when land has a property on it because property appreciates. Land, on the other hand, does not appreciate. This puts the lender’s money at risk. If you walked away from the land, the lender would likely take a loss. Not only is it hard to sell land, but it may not sell for as much as you paid originally. If you walked away from a home, though, the lender has a chance to make their money back. They can sell the home at a higher price than you paid.
There are many factors that make some land riskier than others. For example, if the land is unimproved, you do not have a lot of incentive to continue paying on the loan. Let’s say there are no streets or sewers. You thought the area would get improved in the next couple of years at which point you would build a home. If that does not happen, you are stuck with land and nothing to do with it. Some people would just walk away from the land. Unimproved land has very little value to a lender, which could mean a loss.
Qualifying for a Land Mortgage
Lenders have very specific requirements when qualifying for a land mortgage. The land requirements include:
- You must prove the use for the land. If you plan to build a home, you must obtain the residential zoning. You can obtain this with a survey. It will show whether you can put a home on the land or if it is zoned for commercial use. If it is not appropriate for a home, you cannot secure a land mortgage for residential purposes.
- The land should be improved. Some lenders may allow unimproved land, but they are few and far between. Improved land increases the likelihood of you building a home on it in the near future.
Next, you must qualify for the loan with your own factors. Each lender has their own requirements. A general overview of what lenders require includes:
- High credit scores – There is not a minimum credit score like there is for say FHA or conventional loans. Each lender sets their own parameters. Generally, the higher the score, the better, though. A high credit score shows financial responsibility. This gives the lender confidence that you will not just walk away from the land, leaving the lender with a loss.
- High down payment – Again, each lender has their own requirements. But, it is not unusual to see down payment requirements as high as 40-50% for land. This gives you “skin in the game.” You are much less likely to walk away from a loan if you have 50% of your own money invested. If you do walk away, the lender has a lower likelihood of taking a loss since you invested so much already.
- Stable employment and income – You should have the same job for at least 2 years before applying for a land mortgage. This shows the lender stability and consistency with your income. If you have a new job, the lender does not know how consistent or reliable the job may be. This could put their investment in you at risk.
Getting the Land Mortgage Approved
Once you meet the above requirements, you must show the lender you have a plan for the land. You cannot just say you have an interest in a piece of land. You need a plan – a written plan. This shows the lender how you will use the lot. Will you build a home yourself? Are you going to hire a homebuilder to construct the home? When will this happen? Do you have what it takes to qualify for the construction loan? These are factors the lender considers when determining if you can qualify for the land loan.
Buying Land at the Same Time as a Home
If you know you will build a home on the lot, you may want a construction-to-permanent loan. This allows you to buy the land, pay for the home construction, and flip it into a permanent loan. While it sounds more complicated, it may be easier to qualify for than a land loan. This loan requires you to build a home. That home gives the lender collateral for your loan. However, construction must start right away on a construction-to-permanent loan. Lenders usually require completion of the project within a year. If you don’t have the funds or immediate plans to build a home, it won’t’ be a viable option. The requirements are fairly similar to the land loan:
- High credit score
- Low debt ratio (maximum 36%)
- High down payment (at least 20%, but usually more)
You also must find a builder the lender approves of before you can close on the loan. The builder must pass the lender’s requirements. This includes having proper licensing, insurance, and industry experience.
A land mortgage is a possibility, but a risky one. You may have to shop around with different lenders. Do your research and determine what you will use the land for. If you can show the area improved and many people build there, you will have a better chance. If, on the other hand, you find land in an area where no other homes are, you may have a harder time.
Work on building up your credit, savings, and stable income history before applying for a land loan. This way you show the lender you are not a high risk. The riskier your qualification factors, the lower your chances of approval on a land mortgage. If you can sweeten the deal and apply for a construction loan, you may have a better chance. Either way, though, you need great credit and plenty of savings. The earlier you start preparing yourself, the higher your chances of approval.