Purchasing land is exciting. It gives the opportunity to do whatever the owner wishes with it as well as granting a sense of security. However, most people are unable to shell out the entire cost of the land purchase, and thus will need to borrow some money. There are some options to financing a loan for all walks of life, those with good and bad credit and for those looking to purchase the land for residential or commercial use.
The 3 most common ways to finance land include:
- Traditional Financing
- Owner Financing
- Using Home Equity and 401(k) Loans
It is more complicated to finance land than to simply get a mortgage for an already constructed building due to the inherent risks involved to the lender. The land itself needs to be considered, its location, zoning laws, and how the land is going to be used, as well as how likely the borrower is going to follow through with their payment agreements. Read further ahead to learn about the different ways of financing the purchase of a parcel of land.
Article Contents
How Do You Finance Land to Buy?
Financing within the real estate world means borrowing money from a lender, usually a bank or the owner itself, in order to make a large purchase such as that of a house or a parcel of land.
The definition of financing according to the Merriam-Webster dictionary is the act or process or an instance of raising or providing funds. Financed purchases are loans and thus will need to be paid back over a set period of time, usually including interest at set rates. This interest accrues over time and will inevitably have the borrower spending more overall than their initial loan cost.
These sorts of loans are typically granted to people looking to make large purchases such as vehicles, real estate, and land. Anyone with a mortgage has had to go through a lot of the same experiences financing as they will need in order to buy a fresh parcel of land.
However, financing a parcel of land is not as straightforward as taking out a mortgage for a house or another building. Other things need to be taken into consideration, such as the zoning laws of the area, location, and the intention of how the land is going to be used. It is typically recommended to hire a lawyer or another professional to help ensure that all of these requirements are being met.
Is It Hard to Get a Loan for Land?
Land loans are riskier for a bank to make as it’s far easier for the borrower to walk away from the agreement. What is most important to the bank is the local zoning laws, location of the land, how it is going to be used, and the land quality itself. They also typically rely on a good credit score, though there are options for potential borrowers who do not have stellar numbers.
The 3 Most Common Ways of Financing a Land Purchase
Unless a potential buyer has all of the cash at hand, they are going to have to get some help in order to pay for the purchase of the land.
These are the three most common ways of financing a land purchase:
- Traditional Financing
- Owner Financing
- Home Equity and 401(k) Loans
Now, let’s dive deeper into each of these ways of financing a land purchase.
Traditional Financing
Traditional Financing means going to a bank and shopping around for loans. The best bet is to find a local bank or provider, as they will have a better understanding of the area in question and thus will help get the best rate possible compared to a massive national corporation that has little to no idea what things really cost.
Here are some pros and cons to traditional financing options:
PROS
- Peace Of Mind
- Warranties and Securities
- Handle Most of the Expenses and Legalities
- Always Someone to Fall Back On
- Understand Local Values
CONS
- Lower Spending Limits
- Larger Down Payment Requirements
- Higher Interest Rates
- Shorter Terms
- More Required Fees
A bank wants to protect their investment in the financed property just as much as the borrower. They are lending out the money in order for the borrower to purchase the land on the faith that eventually it will all be paid back. That means that they have a lot more resources at their disposal to ensure a land purchase is going to be done legally and with the lowest risk involved.
However, that means that they also want to ensure they are making a profit themselves, and thus some rates will get to be higher than with some other loan options.
Owner Financing
Sometimes it’s easier to just convince the seller to finance the land themselves instead of going through a third party. This is often an attractive deal for those who are savvy with negotiations, or personally know the seller. The drawback is sometimes sellers over-value their own land due to wanting to make a return on the work they have put into it.
There are two traditional methods to Owner Financing to consider:
Contract for Deed Land Installment Contract
- Allows for purchaser to make payments directly to the former owner over a predetermined length of time
- Typically has a large final payment
- Easier for those with poor credit to obtain
- Best for long term plans that can wait until the payments are finalized and the deed is transferred
Mortgage/Trust Deed Deed of Trust
- Seller issues the deed in return for a promissory and mortgage contract
- Mortgage on the land acts as collateral against the promissory note
- Best for immediate access to building on the land
- Requires a third party to legalize and handle
Each option for owner financing has its perks and drawbacks but can be a steal in some situations. Especially if the borrower’s credit isn’t the greatest or are trying to purchase land from someone they already know.
Home Equity and 401(k) Loans
If a potential land purchaser already has a home with sufficient equity, then it can be used towards land purchases. It’s an attractive option for long-standing homeowners who are looking to build their dream home or to add some acreage to their current land.
Home Equity Loans have some great perks as well such as:
- Easy to obtain (as long as the current mortgage has been responsibly handled)
- Uses money built from current mortgage
- Low interest rates
- Favorable repayment plans
- No surprises on how it’s going to be handled
Another common potential, if an employer allows, is to take money from a company 401(k) plan. As these savings are already there, some areas and companies allow borrowing against it in order to make a land purchase. However, this option only allows access to a short-term loan. At least it means that there are funds to lower any additional costs needed for a larger purchase.
How Can I Finance Land with No Money Down?
A 20% down payment is ideal in any loan servicing situation, and land is no different. The drawback of not putting any money down for a down payment is that it will increase how much needs to be paid back over time, leading to more interest.
In order to finance land without any money down, the borrower’s credit is going to have to be stellar. Lower credit requires higher down payments and generally comes with higher APR rates, while higher credit tells the servicing company that you are trustworthy and stick to payments as arranged.
It’s generally agreed that a credit score above 620 will grant a decent loan, and anything above 700 will almost certainly grant a good one. Scores above 750 will be greatly received and will give little to no problem finding a servicer willing to do low to no money down for the loan.
The other option is to find an owner who is willing to personally finance over a long period of time and get involved in some good owner financing options. That way things can be negotiated personally between the buyer and the seller, and thus can negate the need for an initial down payment.
What Kind of Information is Needed for Financing a Loan?
Even getting a mortgage is not as simple as walking into a bank and asking for one as if it were a book of checks. There are some documents that they are going to request, and it’s going to take some time to get it all processed. Typically, a loan servicer will let potential borrowers know everything they are going to need to bring with them in a meeting.
Information needed for financing a land loan includes:
- Land Portfolio: Information about the land and plans for it
- Work History: Typically at least 2 years as well as income
- Personal Identification: Driver’s License, Social Security Number, Passports, etc.
- Credit Report: Typically performed by the provider
Now, let’s take a look at the funds you will need for a financing loan.
What Funds Are Needed for a Financing Loan?
Additionally, there will also be the need for liquid funds for final costs
Funds needed for financing a land loan includes:
- Down Payment (if required)
- Service Fees
- Legal and Zoning Fees
- Closing costs
In the end, any additional information and fees will be subject to local ordinances, laws, and providers.
Conclusion
Purchasing land is a fascinating experience, albeit a long and difficult one. So much is restricted to local laws, ordinances, and standards that compiling a comprehensive list is mind boggling. It all matters on the borrower’s personal credit history, intentions for the land, and how feasible it is to actually purchase the land in question.
It is important to consider how much land one can afford as well as options for financing the land itself while still leaving funds for the projects at hand.
The good news is that there are options for every scenario, even if they are scary and complicated. People in the position to help finance a loan are there trying to get people to do so. They want people to borrow their money and pay it back with interest. Sellers want to get rid of this land, otherwise they wouldn’t be trying to sell it. With some good knowledge and some Class A negotiation skills, getting ahold of that dream parcel of land is only a little loan away.
