Why Do Banks Treat Lot And Land Loans Differently?

From a borrower’s perspective, it often is more difficult to get lot and land loans than it is for the same borrower to get a loan for buying a built home. Understanding the bank’s perspective can help explain some of the reasons why lot loans and land loans are treated differently by banks.

In the first article in this series we discussed how your own personal situation and needs can help you decide whether you should seek a construction loan, lot loan or land loan for buying a homesite and building a new home. In other related articles we explained how Home Construction Loans have their own unique requirements and procedures and also described the terms for Lot and Land Loans in more detail.

Borrowers who are seeking financing will learn that lot and land loans can be both harder to acquire and have less favorable terms when compared to the typical “purchase money” loan for buying an existing home. In fact, you may find that some banks just don’t offer lot and land loans at all, or only provide them with onerous loan terms that you would not even want to consider.

So what’s Wrong with Loans for Lots and Land?

Lot and land loans can have negative connotations for many in the banking industry. Most banks have recent bad memories after taking losses related to lot and land loans (along with other real estate loans) during the housing market collapse and economic downturn. And many financial institutions still are trying to recover from financial difficulties of their own. So with increased regulatory oversight, mandated capital requirements, market uncertainty, rigorous underwriting procedures and bad memories, some banks still have not returned to the point where they wish to originate and keep lot and land loans on their books.

Lenders generally consider land to be a riskier form of collateral when compared to existing homes. If the property at issue truly is vacant land (with no other structures or assets of value on the property) then the land itself will be the only on-site collateral for the lender. Land is not easily converted to a built home, the preferred residential mortgage collateral for many lenders. Likewise, lenders worry that when you borrow to buy vacant land you are not as incentivized to repay the loan as you would be if the property were your primary residence. A borrower is less likely to default on a loan when it would cause them to lose their home.

In addition, lot and land loans are “nonconforming” loans. This technical term is used in the lending industry to mean that a loan does not conform to the nationally standardized guidelines for mortgages established by Fannie Mae and Freddie Mac. These guidelines set maximum “conforming” loan amounts and other criteria, but also require that the loan be secured by a property with completed improvements built on it. Without a completed home as collateral, a loan for purchasing a vacant residential lot or land will be considered nonconforming. These nonconforming loans are not as liquid for the originating lender because, unlike purchase money loans for homes, they cannot easily be sold in portfolios of loans to other financial institutions on the secondary loan market.

Foreclosure is Not an Attractive Option for Banks

Although many consumers have a hard time believing it, banks actually do not want to foreclose on properties. Banks primarily make their profits lending money, not managing real estate, so foreclosure is not their preferred path to exit from a loan. And when they do foreclose, the residential lending groups for banks usually are designed to manage and liquidate the existing built homes that are the most common collateral for their loans. These REO (Real Estate Owned) groups at the bank know that selling lots or land is different when compared to selling a home for many reasons, so lots and land don’t really fit into their standard operational profile. Even more so than existing homes, lenders really don’t want to acquire empty lots or vacant land properties through a foreclosure.

But Lot and Land Loans Can Be Good for Business

Despite these concerns, many banks realize that in the right market conditions it is good business for them to provide lot and land loans to customers. From a bank’s perspective, a lot loan can be a way for it to build business. Even lenders that don’t have active lot loan programs may make exceptions to retain or acquire valued banking customers. The bank hopes that new customers will start with a lot loan and then they will come back to them for a construction loan, long-term financing and other banking products. Learn more about finding lenders for lot and land loans in this related article.

Each borrower’s situation is different and each bank is different. And even though some banks don’t love lot and land loans, if you are prepared and reach out to a variety of lenders or mortgage brokers to learn about your options you can find the opportunities that are right for you.

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