That perfect piece of land with mature trees and a lake has come up for sale. Your family has talked about building a house in the next few years. Now, you just need to get a land loan before any house can be designed.
Is getting a land loan the same as a home mortgage?
Well, there are some big similarities and some differences, says Jim Nowak, regional vice president and sales & customer rel ations for the Mid-East Region of GreenStone Farm Credit Service in East Lansing, Mich. Independently owned Farm Credit Service (FCS) offices across America and Puerto Rico help rural communities with loans and leases. For those getting land loans, the FCS can help people wanting just a single lot or thousands of acres.
Land loans can be purchased with cash or through seller financing, bank financing or an equity loan or equity line of credit secured by your existing home. Also, the U.S. Department of Agriculture offers a program for low-income borrowers called Section 502 direct loans. These loans allow people to buy property with plans to make improvements needed and to add a house to the lot.
“When you are looking at a mortgage as opposed to a vacant land loan, the first thing that is different from a financial institution’s perspective is that a land loan or vacant lot loan is a little bit more risky,” Nowak explains. “There is no home on the lot for collateral, which is what a regular home mortgage takes into consideration. So that means that the interest rates will be a little higher on a vacant land loan.”
Land loans are riskier
Nowak explains that banks believe these loans are riskier because of scenarios such as this a family is encountering challenging financial times. If they own a 10 acre piece of land somewhere across town in hopes to someday build their dream house but they are living in their current home, they most likely will stop paying on that land and not their house, he explains.
“Throughout time in history, banks have viewed vacant land not as comfortable on their portfolio,” Nowak says.
When it comes to the higher interest rates to help with the fear of defaulting, banks and other lenders have their own varying scales. But he said many times a land loan will be at least 1% – 1.5% more than just getting a mortgage for an existing home.
“We have many people who come to us and don’t even realize there are loans out there for vacant land. Some think that to buy a home site before you build on it, that you need to pay cash for that,” he says. “That’s not the case. Loans for vacant land at Farm Credit is what we specialize in.”
It doesn’t matter if someone is buying the land for hunting, fishing or to eventually build a house, the land loan would be the same.
As far as the terms for a land loan, many banks and financial institutions do not offer 30 year loans like they would for a home mortgage. It’s best to check with your lender to see they type of terms and interest rates being offered for vacant land.
“The banks usually will offer a 5-year adjusted rate mortgage with a balloon payment at the end,” Nowak states. “But at GreenStone, we actually will finance a land loan on a 30-year fixed term. That’s the niche we have. It’s very, very rare. But we’ve been doing it since I’ve been around for 12 years.”
He says after doing it for 100 years, the FCS feels comfortable financing land since the organization has been doing it for 100 years and taking land as the collateral. And it doesn’t matter if it’s just one small lot or 200 acres.
However, the terms are different for farmers not potential housebuilders.
“We, generally speaking, will fund 65 loan-to-value — meaning customers put down 35% of the purchase price, and generally, the term will be at 20 years. There certainly have been exceptions made, and we have gone to 25 and 30 year fixed terms for farmland,” Nowak says.
When someone wants to purchase a vacant piece of land or even a small two acre lot, those are the parcels that will go up to 30 year terms, he says. If it is a very large purchase, the FCS credit department would rather like to have 25 years plus 20% down on most vacant land.
Similarities of a land and home loans
“Underwriting is one of the things that is very similar when you talk about home mortgages and vacant land,” he adds. “We collect the same financial information, and we still have to get title work and appraisals done. Those are the similarities.”
In Michigan and in many parts of the country, a land loan – especially if it will eventually be a home site (which is classified under 10 acres) — lenders require a percolation (or perc) test to determine the absorption rate of soil so a septic system can be placed there and a home built on that land.
Other differences of home mortgages and vacant lot loans can save you some bucks. For instance, there are no insurance requirements when you buy vacant land, Nowak says. However, when you have a home mortgage, every financial institution will expect you to get property insurance on the home to protect both you and the bank if disaster should hit.
“Also, most financers will expect the borrower to get mortgage insurance if they put down less than 20%. With vacant land, there is no such thing as mortgage insurance or PMI,” he says. “That can save you a lot of money.”