What is a land loan?

Land loans are financing options you can use to purchase a plot of land. Most individuals obtain a land loan to buy property that they plan to build a home on within a few years. Land loans typically have shorter terms than standard mortgages (often two to five years) and may require larger down payments.

How do land loans work?

People use land loans to finance the purchase of land they plan to build houses on in the future. These loans have similar requirements to traditional mortgages: You’ll generally need to have a low debt-to-income ratio and good credit to qualify.

Land loans may have more stringent requirements than traditional mortgages, including larger down payments.

A big difference between land loans and traditional mortgages is the average term length. While most conventional mortgages have 30-year repayment terms, land loans are usually much shorter and typically have two- to five-year terms. Most land loans also require a balloon payment at the end of the loan term, which is a large lump-sum payment used to pay off the remaining balance. Traditional mortgages typically have equal, fixed payments over the life of the loan.

Land loans are not as widely available as traditional mortgages and may be more difficult to find. In general, they are riskier for lenders to offer because there’s often less collateral value in land than there is in property with a home on it. In addition, land loans typically have higher interest rates that can be almost double those of traditional mortgages, depending on the market. 

Lenders will also have more stringent requirements for land loans than traditional home loans. For example, some conventional mortgages may allow a down payment as small as 3%, while the minimum down payment on land loans is at least 15%.

These high down payments can be a deterrent for some borrowers. One Virginia resident told us they opted to refinance their home instead: “We looked at going and getting a land loan, and we found out that it was going to cost us a fortune because you had to put so much money down,” they said. “You had to put down like 25% in order to get a land loan, and we didn't want to do that.”

Land loans vs. construction loans

Land loans are often confused with construction loans, which are a similar financing option. Land loans are for borrowers who may have plans to build in the future but not right away.

Construction loans are for individuals who plan to purchase a plot of land and begin building on it immediately. Like land loans, construction loans are also short-term; however, they are often converted into a traditional mortgage after the home is built and the loan term has ended.

Types of land loans

There are three main types of land loans: raw, unimproved and improved. Which one is right for you will depend on the type of land you plan to purchase.

Raw land loans

Raw land loans are used to purchase properties that have not been developed at all. These properties generally don’t have any access to utility services like electricity.

You may decide to purchase raw land with the intention of building your dream home later. However, to secure the loan now, you’ll need to present a fairly detailed plan to the lender explaining how you will develop the property.

This plan may include architectural drawings for the home and a project timeline for the building process. Essentially, the lender needs to see that you’ve done your homework, learned what building a home entails and evaluated its costs.

To be eligible for a loan on raw land, you’ll generally need to offer at least a 35% down payment, which means your LTV (loan-to-value) ratio should not exceed 65%. These guidelines come from the Federal Deposit Insurance Corporation (FDIC), which sets LTV ratio limits for most lenders.

Unimproved land loans

Unimproved land loans are used to purchase real estate that is more developed than raw land but not entirely connected to the grid. These properties may already have some utility hookups but lack other essential items (like electric meters). Loans for unimproved land are slightly easier to obtain than loans for raw land, mainly because unimproved properties are more primed for building.

To qualify for this type of land loan, you’ll usually need to offer at least a 25% down payment.

Improved land loans

Improved land, also known as a “lot,” already has full access to utility services and roads. These land loans are easier to obtain than raw and unimproved land loans because the land is more developed; however, they also tend to have a higher purchase price than the other two alternatives.

Loans for improved land have less stringent requirements than raw or unimproved land loans. You’ll need to offer at least a 15% down payment, but interest rates are typically lower on this type of land loan than on the other alternatives.

How to get a land loan

Like with traditional home loans, different lenders offer different types of land loans, including government-backed loans, private loans and seller-financed options.

USDA land loans

USDA loans can be used by low- to moderate-income borrowers to purchase land and build a home, but the property must be located in a rural area. Combination Construction-to-Permanent (Single Close) loans even let you finance your land purchase and your home’s construction with just one closing process.

To qualify, you’ll need to have a low enough income for your area and a debt-to-income ratio of no greater than 41%. There are no down payment requirements, but there are some limitations to how you can use the funds. For example, you must use a USDA-approved contractor to build the home.

Lender land loans

Since many national lenders don’t offer land loans, you may want to look at smaller, community-based financial institutions to explore your options.

Local credit unions with an established presence in the area are more likely to offer these types of loans. You may also research financial institutions that are part of the Farm Credit System — these lenders tend to specialize in land and construction loans.

Each lender has different loan requirements, so you’ll need to know the type of land you want to purchase and what you’ll use it for. For example, some lenders require plans to build a home on the property in the near future. There may also be acreage limitations.

Seller-financed

Through seller financing, you and the seller may be able to work out a repayment agreement without getting a third-party lender involved. You’ll sign a legal document, called a land contract, which details the terms of the agreement.

The loan term is generally short, and you’ll probably pay a higher interest rate than you would if you received the loan from a bank. This type of financing also usually requires a balloon payment at the end of the loan term, which may be problematic for some.

However, this may be a good option for borrowers who don’t qualify for other land loans. You’ll want to consult with a real estate attorney to ensure that your stake in the property is protected with the land contract, though.

Home equity loans

A home equity loan uses the equity you’ve built in your current home to finance a large purchase — like land. Because your home is used as collateral, it may be easier to obtain this type of financing than if you specifically applied for a land loan. However, you could lose your home if you stop making payments.

There are no down payment requirements with a home equity loan, and you can repay the loan in fixed, equal monthly payments. Interest rates are usually lower as well. The repayment terms are also longer, usually between five and 30 years, compared to two- to five-year land loan terms.

This could be a good option for homeowners with long payment histories, but remember that it can be risky to use your home as collateral on a second mortgage.

I want to build a house — where do I start?

If you plan to build your dream home, you’ll want to make sure that you’re aware of the potential costs first. 

As a general rule, most homeowners spend $100 to $200 per square foot on new construction, and the average total sale price for a newly built home (including land) was $485,128 in 2020, according to a study by the National Association of Home Builders. Total construction costs made up 61.1% of that figure ($296,652).

When looking at land options, remember that fully developed land is usually easier to get a loan for than raw land.

Materials and labor prices can vary depending on many factors, so you’ll want to investigate these costs with a local builder.

Next, you’ll need to decide what type of land you want to build on. Some homeowners choose to buy in areas where a developer has already purchased. In those cases, you’ll usually work with a specific builder who may already have a small selection of plans to choose from.

In some cases, the home plan could be set, but you’ll have the ability to design the home's interior to your preferences, like selecting finishes for cabinets.

Another option is to build a custom home, which is when you purchase the property and hire a builder. Keep in mind that improved land with access to utilities and roads is easier to get a loan for than raw land.

Once you know the type of land you want to buy and build on, you can shop around for financing. The type of land you want to buy (raw, unimproved or improved) and how you plan to use the property (building a house now or later) will affect your lending options.

Bottom line

In a fast-paced housing market, where homes are listed and sold within days, you may consider buying land and building your dream home instead of competing with buyers for existing houses. However, you’ll need a different type of loan to finance your big plans.

You may want to look into land loans, which would supply the funding you need to secure a plot of land for later building. However, a construction loan may be a better fit if you're ready to buy land and build a home now.

Either way, before you research lending options, you’ll want to consider what type of land you want to build on and when you plan to construct your dream home. These factors will impact the loan options available to you.