Securing a land loan requires diligent planning

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Ask a Lender
May 26, 2017 | Updated September 18, 2017


Key Points

Land loan basics

  • Before purchasing, make sure the land is zoned for your intended purpose.
  • Lenders charge higher rates on “raw” (unimproved) land.
  • Regional- or community-based lenders may offer more favorable loan terms.
  • Owning property, even unimproved land, will entail property-tax payments.

If you’re planning to build a home from scratch in a quiet, secluded location, you might be aware that construction loans provide a short-term financing solution to handle the building costs.

But construction is only one consideration. You also need to acquire the land the house sits on. To do that, you may need separate financing, known as a land loan.

Preapplication process

There’s a lot of work to do before approaching a land-loan lender, however. If you’ve identified land that’s attractive for a construction or investment opportunity, you first should research the local zoning codes. Cities, towns and counties often have master plans that dictate which areas within their limits may be developed, and what types of developments are allowed. You won’t be allowed to build a home on a site that’s zoned for commercial or industrial use only, for example.

Deciding whether to purchase raw or improved land is another fundamental step. Raw land has not been improved in any way, so lenders may look less favorably upon the property because there is extra risk in the value of the collateral for the loan. Thevalue of raw land is dependent on spending additional funds to prepare the land for construction. Improved land has access to utilities — sewers, water, electricity, natural gas, etc. — and connections to roads. This gives it an inherent value because it is ready for construction.

Hiring a certified land planner could be a way to remove some of the personal headaches associated with the preapplication process. A land planner will gather information about the property and order a survey to establish the property boundaries. They’ll identify any potential environmental issues stemming from existing vegetation, soil or groundwater, as well as any easements or encroachments that could restrict usage of the land.

Finally, identifying a local or regional lender, such as a credit union or community bank, that does land loans can help kickstart the process. These local institutions are generally more in tune with the area and its housing market than national enterprises. They also often have specialized lenders that work entirely with land development and valuation. Although larger, nationwide lenders will approve land loans, they’re more apt to demand higher down payments and charge higher interest rates.

Land loan options

When deciding between raw and improved land, one consideration is whether you plan to build a home in the near future or simply want to buy the land as an investment. Raw land in an area not currently being developed may not be usable for quite some time, but could appreciate in value by the time a developer decides to improve the area.

But be prepared to pay higher interest rates, as mentioned earlier, due to the higher risk that the lender is taking on if you default before the land appreciates. In addition to higher interest rates, lenders may require up to a 50 percent down payment to account for the added risk.

If you’re looking to build immediately on improved land, you can secure what is called a lot loan. This type of financing generally has smaller down payments — 20 percent or less — and can be amortized for up to 20 years. Other land loans offer short-term, low-interest financing and even zero down payments. These types of loans will need to be paid off within a year or two, but that can often be done after construction is complete with a traditional 30-year home loan that pays off both the land and construction loans. Some lot loans will even give you a couple years to solidify housing plans, select a contractor and roll your lot loan into a short-term construction loan.

Property-tax considerations

Taxes are a fact of life for any property owner, so regardless of whether you’ve made any improvements to your land or not, you will need to pay property taxes on that property based on your local government’s assessments.

There are tax benefits to owning vacant land, however, no matter if you are using it for personal or investment purposes. For personal use, you can use an itemized-deduction form, or Schedule A, to deduct property taxes when filing your federal income taxes. An exception exists for high-income earners who are subject to alternative minimum tax — those individuals lose their rights to itemized deductions.

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