If you’ve always wanted to build your dream home on land, the first step is to understand how to finance undeveloped property. The process of financing undeveloped property is a bit more complicated than buying an existing home, but below you’ll find the basics to help you get started.
Lot vs. Land
Are you buying a lot or raw land? Although the difference might seem small, a lot is often easier to finance, as banks generally feel more comfortable financing this type of undeveloped property rather than a larger tract of land. Check with your bank to see if there is an acreage threshold that separates a lot from land, as this can affect the terms of your loan. Raw land is often more difficult to finance than a lot in an established subdivision.
Preparing A Down Payment
A large down payment is required in order to finance undeveloped property. This is the case because the amount of the loan is calculated by using a Loan-to-Value, or LTV, ratio. The LTV is found by dividing the loan amount by the value of the property. When you choose to buy a lot or land, the LTV is lower than a home that has already been built. A lower LTV must be made up for with a bigger down payment. Try to save up as big of a down payment as possible, as sizable down payments are very helpful in financing undeveloped land. Most lenders like to see a minimum down payment of 20 percent, with some lenders preferring to see a down payment of up to 50 percent.
Length of Loan
Most lot and land loans need to be paid off very quickly, typically no longer than two years. Some loans must be paid off within just a few months. Although most borrowers tend to think of loans in terms of 30 years, this is not the case with financing raw land. When borrowing money to purchase land, be absolutely sure that you’ll be able to pay off the loan within the specified time frame. If you fail to make the payments, you’ll be forced to refinance or pay off the loan in full.
Lot and land loans often have higher interest rates than other types of loans. However, it’s possible that your lender will allow you to make interest-only payments.
Land and lot loans are quite different from the average mortgage loan. When you’re ready to apply for this type of loan, keep in mind that they require a large down payment, often have higher interest rates, and that you must be prepared to pay off the loan in a short period of time.