The process of buying land and building a house can be confusing, especially if you’ve never done it before! There are different ways to finance the property and the construction of your home, and your lender should be able to help you choose what fits best for your financial situation. This article will teach you the difference between land loans and mortgages, and introduce you to financing options for buying land to build a house.
If this is your first time purchasing land to build a home, make sure to check out our article about things you need to know before buying land to build a house.
Differences and Similarities Between Land Loans and Home Loans
Differences (due to the higher risk factor):
Lenders require a larger down payment for a land loan as opposed to a traditional home mortgage loan.
Interest rates are typically higher for land loans due to the higher default rate.
If a lien is placed on a land loan, when you are ready to start construction, the land loan will need to be refinanced into a home construction loan. This is usually an advantage because you can term out the home loan over 30 years and reduce your overall monthly payment.
Land loans with no home on the land are capped at 15 years through MidAtlantic Farm Credit, while home mortgages can go up to 30 years.
Land loans are typically more expensive than purchasing a prebuilt home and land. The benefit of buying and constructing is creating your dream home.
The similarities between land loans and home loans:
Both land and home loans require a mortgage to be placed on the property.
The lender will place a mortgage or a lien against the land, just like on a traditional home loan.
MidAtlantic Farm Credit offers both fixed rate loan option mortgages and bare land loans.
Why are land loans seen as high risk loans?
Land loans are a higher risk for the financial institution because there is typically no existing structure or home on the property. When someone purchases land, they often already have a mortgage or rent payment. If financial difficulties were to occur, that person would be more likely to default on a land loan with no structure instead of their mortgage or rent – in fact, this is why most lenders don’t finance bare land!
What are the typical down payment and loan terms for land loans?
Because of the high risk factor, land loans require 20% down whereas conventional financing can require as little as 5% down. In addition, rather than the typical 30 year mortgage for home loans, land loans may be capped around 15 years.
Can I use any current equity in the land I already own towards the down payment and closing costs?
Mount Joy Loan Officer, Rhiannon Levan, gets this question a lot – here’s her answer: “Yes you can! Taxes and insurance would still need to be paid out of pocket at time of modification, but we are able to use any equity in the property owned for down payment. This especially comes in handy for customers who are given/gifted land that was subdivided from a family farm.”
Is it cheaper to buy land and build a home?
This will depend on what you’re in the market for, but for arguments sake, not usually. Land loans are typically more expensive because they do not contain a home or dwelling. When someone purchases land they are likely already renting or have a mortgage payment of their own. This can create a potential delinquency risk because land owners are more likely to default on bare land over a property with their home on it, if financial troubles arise. In order to offset the greater delinquency risk, a higher interest rate is charged.
Another reason it is usually more expensive to buy land and build a home is because bare land is not as desirable as a prebuilt home – you have to be able to see the potential in the land before it comes to fruition. The construction process can take up to a year (or more) and most families do not have the flexibility of waiting for their home to be constructed. There are also other fees like permitting, site work (i.e. well and septic), architectural costs, and construction cost overruns that may make building more expensive.
One common misconception to note here is about the valuation of a new build. Many new homebuilders think, “If it costs me $300,000 to construct my house, I will appraise for at least $300,000 or more, since it is a new build.” Mount Joy Loan Officer Katie Moore cautions against that thought:
“Although building your dream home allows you to construct a home to your liking, it is important to remember that the cost to build does not always equate to appraised value. There are a variety of other costs that need to go into building that do not exist with buying a prebuilt home, such as architectural fees, labor, permitting, and storm water management that don’t always translate into equity.”
If I'm buying land now, is it cheaper to also build my house now?
Yes, it is typically cheaper to buy land and build a home at the same time. Doing so can reduce the number of loan closing fees, result in a lower interest rate (since there will be a dwelling on the property), and your rate can be locked in at the time of the land purchase, that way you do not need to worry about rates changing during the time it takes to build your dream home.
Can I buy land and build a home with one loan?
Yes, you can buy land and build a home with one loan. At Farm Credit, we call this a Construction to Permanent Loan (C2P).
In order to apply for a construction to permanent loan, you will need a completed construction contract, blueprints and specifications for the lender to complete an “as proposed” appraisal. This type of appraisal uses the resources you provide to determine the estimated appraised value for after the home construction is complete. Once the value is determined, the lender can loan up to 80-95% depending on the program*.
During the construction of your home, you will only make payments based on the amount that has been drawn against the project. A loan modification (instead of an actual loan closing) will take place after the construction is complete. If possible, your rate will be lowered at the modification.
What are my options with MAFC when building?
If you’re looking for a one-time loan close with a contractor and contract in-hand, we offer land and home construction loans to help make the home building process easier.
Contact us with your questions or if you’re ready to jump in. We’re happy to help find the best solution for you.
*Take into consideration that it can take several months to get the construction contract, blueprints and specifications completed. This can potentially impede the process if the seller of the land is not willing to wait this long or sells to a higher bidder.