In our first article in this series we help you decide between loan types, and whether your situation means you need a construction loan, lot loan or land loan for financing a lot purchase and building a new home. We’ve also described the details about home construction loans and their unique terms and procedures. This article gives you some more information about the particulars of Land and Lot Loans.
It’s safe to say that loans for vacant land are different than “purchase money loans” for buying already-built homes, and there are a number of reasons why banks treat land and lot loans differently. In this article we describe what those differences mean from a borrower’s perspective, including details about the loan terms, additional underwriting requirements and other characteristics of lot and land loans.
Lenders may Distinguish Between Lot Loans & Land Loans
Although we’ve included loans for lots and land in the same discussion here, there even can be differences in a lender’s loan terms and requirements based on whether the property is a finished lot in a platted subdivision or is a vacant, undeveloped parcel of land.
The loan terms and underwriting for a formal lot with a road and utilities may be less rigorous than loans for undeveloped land. A finished lot can give the lender more comfort, as it is another step closer to being ready for a new home (the preferred form of collateral for most residential lenders).
In addition, be aware that some lenders may use acreage thresholds to decide whether to classify your property as a “lot” or “land”, which can affect your loan terms. Requirements can vary by lender, but a larger undeveloped parcel is more likely to be considered vacant land. Note that undeveloped land that is being bought with no expectation of building a home or adding site improvements can be particularly hard to finance using the residential lot and land loans discussed here.
Terms for Land & Lot Loans
So from a borrower’s perspective, what are some of the differences between lot and land loans and standard purchase money loans for existing homes? Loan terms can vary greatly depending on the financial institution, the borrower and the lending market conditions, but borrowers are likely to see differences in the following areas:
- Down Payment/LTV
- Loan Length
- Interest Rate
- Underwriting & Processing
Banks treat land and lot loans differently, and prefer to process purchase money loans for existing homes over land and lot loans. Whether it’s because of a bad history with lot loans, regulatory restrictions, market conditions or the fact that lot and land loans are “nonconforming”, some banks simply do not offer lot and land loan programs. Because of this, borrowers will find that it is harder to get this type of financing. Less lending competition also means a borrower will have fewer options and less room to negotiate on terms when evaluating loan packages. Read our related article that describes some tips for finding a lender for a lot or land loan.
Land and lot loans often require higher relative down payments from borrowers. The amount of the loan – and the corresponding balance to be paid by the borrower as a down payment – is determined by the lender using a Loan-to-Value (LTV) ratio. The LTV is calculated by dividing the loan amount by the property’s value (or its purchase price, if lower).
A borrower getting a lot or land loan will likely see a lower LTV ratio used by the lender when compared to a purchase money loan for buying a home, and a lower LTV means a higher percentage down payment is required from the borrower. For purposes of comparison (a) a borrower for an existing home purchase may see LTVs as high as 100% (which equals no down payment), (b) borrowers under loans for finished lots can see LTVs up to around 90% (down payment of 10% of value) and (c) borrowers that are buying undeveloped, vacant land may be limited to a maximum LTV of around 70% (down payment of 30%). Some borrowers will find that banks that are not fond of lot and land loans may even propose LTV ratios as low as 50%.
Land and lot loans usually are short term loans. Many consumers are familiar with 30 year home mortgages for buying existing homes, but unfortunately that type of loan term length typically is not available for a lot or land borrower.
A lot loan may be restricted to a payoff date of a few years (or even months), in the lender’s anticipation that the borrower will be building a home on the lot in the near future and paying off the lot loan with a construction or permanent loan. In addition, a borrower for a lot or land loan may be required to commit in writing a statement of intent that they will begin building a home on the property by a certain date. If they fail to start building or meet deadlines by the maturity date, the borrower may need to refinance, find a new lender or just pay off the loan altogether.
Likewise, lot or land loans also may be required to be amortized over a shorter time period, which results in higher monthly payments when compared to a longer amortization period. Amortization can be described as a calculation that is done to determine the monthly payment amount (principal and interest) and payment schedule for the life of a loan using a chosen amortization time period. For comparison purposes, your choices may be limited with a land or lot loan to being amortized over 10 to 15 years, instead of even having an option for the 30 year amortization period that is available for most home loan borrowers.
Interest rates can vary greatly, but by comparison land and lot loans often have higher interest rates than purchase money loans for buying a home. Some lenders will allow borrowers to make interest-only payments on a lot loan.
Most home loans only are secured by a mortgage on the property, which means the lender is using the value of the land and home as its collateral for the loan. When you are seeking a lot or land loan, you may find that the lender wants you to provide additional collateral or personal guarantees. Some banks will want you to have banking deposits and other liquid financial assets at their bank in case you default on the lot or land loan. In addition, a bank may seek to cross-collateralize other real estate that you own as supplemental security for your lot or land loan.
Underwriting & Processing
Land and lot loans are structured and documented similar to purchase money loans for buying a home, but lot and land loans undergo more rigorous, hands-on underwriting by lenders. This means borrowers will need to do more paperwork and spend more time getting approved for their lot and land loans. Read more about why lenders treat lot and land loans differently.
Lenders also may require closing items and documentation that are not always required with purchase money loans for buying homes. For example, because the dirt is the primary on-site asset for a lender under a land loan, detailed property surveys usually are required before the bank will fund a loan to buy a lot or vacant land. While surveys are wise to get for any property purchase, full surveys are not always required for buying existing homes. Sometimes a lender will accept a recently filed subdivision plat in lieu of a survey with loans for buying finished lots.
Borrowers also should be aware of “points” and other fees being included in their loan terms. Some lenders will add loan points and fees to lot and land loans that can have a real impact on the borrower’s transaction costs.
When can you skip the Lot Loan?
As we noted in our first article, a lot or land loan is ideal if you have found the perfect property but are not quite ready to build your home. But there may be some scenarios where a potential lot buyer that is not quite ready to build should consider seeking a construction loan instead of a lot or land loan.
For example, if you already have completed much of the design and planning work for your new home, but do not quite have final design documents or a construction contract in place that you would need to get a construction loan, then you still may be able to skip the separate lot loan process. Consider putting the land under contract first and having your lot purchase agreement include a period of time for you to get your plans completed, your contractor ready and your construction financing approved. Then, you could close on the lot purchase at the same time as the construction loan.
This will not work for many buyers because the seller may be unwilling to tie up its property with so many conditions to closing. However, some buyers – like those who are buying from family members who are both patient and trusting – can benefit from this strategy. This unique scenario can help you avoid duplicating the transaction costs you would experience if you had both a lot loan and a construction loan.
Hopefully this helped you understand more about the details and terms for lot and land loans. You also may find it helpful to read our related article about why lenders treat land and lot loans differently. And if you now are ready to look for the right lot or vacant land for you, LotNetwork.com has over 250,000 lot and land listings across the nation that you can search to find that perfect property.
Our next article in this series describes the particulars of Home Construction Loans and helps you understand what a borrower experiences when getting a construction loan to build a new home.
Be sure to read our Resources for Buying Lots & Land and our series of articles about the 8 Tips for Buying Lots and Land, so you can know what to look for (and what to avoid) when buying a lot or parcel of land.
And check out our resource pages with tips and information on the following topics:
- Construction, Lot & Land Loans: What Type of Loan Do You Need? — lotnetwork.com
- Construction Loans: Financing Your New Home from the Ground Up — lotnetwork.com
- Why Do Banks Treat Lot and Land Loans Differently? — lotnetwork.com
- 8 Tips for Buying Residential Lots & Land for a New Home — lotnetwork.com