You found the land you want to purchase to eventually build your home on and cannot wait to purchase it. But you suddenly find that securing financing for the land is not very easy. Why did your friend who built his home from the ground up have no trouble getting a construction loan but you cannot get a land loan? There are many reasons for this situation – lenders do not like to give loans for land alone; they would much rather finance an actual home than the land and will tell you so. If you do manage to get the land loan, you can guarantee that you will be paying much higher interest rates and have less lucrative terms than you would had you purchased an already built home or even built your own home right from the start.
- There is less collateral. The whole point behind a mortgage is the collateral that you provide the bank. When you take out a mortgage on a home that is already built, the home is the collateral. That is easy enough for the bank to accept because if you were to default on the loan, the bank would take the home after a certain number of missed payments. The bank would then be able to turn around and sell your home and get their funds back. It’s not the most ideal situation for the bank because they don’t want to use the resources necessary to sell the home – they would much rather make their profits off of the interest on your loan, but it is their backup plan should it need be used. With a land loan, there is not a lot of collateral available. Yes, they can take control of the land, but vacant land is much harder to sell than an already built home.
- There is not a big reason for you to keep up with your payments. Yes, in a perfect world everyone makes their payments, especially when they buy the perfect land to build their house with a white picket fence. But then there is reality – and reality is that not everyone can make the payments they set out to make in the long run. When you are talking about payments on your house that is already constructed and you are living in it or even the house you are building from the ground up, there is incentive to make those payments because you need a place to live! With a land loan, there is no incentive because it is “just land;” you live somewhere else. If the going gets tough financially, you are likely going to stop making the land loan payments, leaving the bank in the lurches with your loan.
- Land loans are hard to sell. If a lender is not planning on keeping your loan on their books, they are going to have a harder time getting an investor for it. Land loans are not lucrative in the investment world. Investors want loans that have collateral and resale value. Even construction loans have more value than land loans on the secondary market. In general, you will have to find a lender that is going to keep your loan on their books in order to get a loan. This is especially true if you do not have plans to turn that land into a constructed home anytime soon.
- You need a large down payment. Many banks require very large down payments on land loans as well as construction loans. Again, this goes back to the fact that there is very little collateral on this type of loan. Even if you have the construction plans drawn up and are working on a construction loan, you are not providing the bank with a large amount of collateral to work with, which means they need to require a large down payment. It is not unusual to see land loans require 20, 30, or 40% down payments. This is the only way the bank can be sure that you are going to have enough incentive to continue making the payments until you build your home and are able to pay the land loan off.
- You cannot be a high credit risk. Because land loans are non-conforming and are not easy to sell in the secondary market, lenders have to be very choosy about who they lend to. Because you are not dealing with Fannie Mae or FHA guidelines, you will have to deal with the lender’s guidelines, which usually are tougher because they do not want to take on a loan that will be defaulted on in the near future. If you do not have exceptional credit, it will be very difficult to get a land or even construction loan.
Lenders are slowly starting to offer land and construction loans as they ease back into the normal housing market, but the restrictions are still there. We will never see a lucrative housing market as we saw in the early 2000s. Lenders are going to be much more careful about how they lend to especially when there is not a lot of collateral to speak of in the process. If you are looking to purchase land, it is best to consider building on it right away and applying for the construction loan and land purchase loan at the same time. The construction loan is much easier to qualify for than strictly the land loan just because of the amount of risk that is involved in the land loan. When it is all said and done, you have the funds needed to construct your custom home and you have a home to enjoy in the end!Click to See the Latest Mortgage Rates»