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Differences in applying for land loans vs. home loans

On Behalf of | Apr 27, 2023 | Real Estate Disputes

In Washington, you need to secure a land loan if you want to buy a parcel of raw land for a real estate project. Before completing a loan application, you’ll want to consider some critical factors that may differ from more familiar types of financing, such as a home mortgage loan.

Research lenders

A land loan finances raw land with minimal or no existing infrastructure, such as sewers or land surveys. A lot loan is similar but is used to finance land lots with some improvements, such as residential zoning, land grading and utilities.

Before applying for either type of land loan, research lenders and compare interest rate offers, down payment options and other loan terms. The collateral for your land loan is often the land itself. You may need to explain how you intend to develop the land, including surveys, zoning checks, utility access and any restrictions on the land’s use.

Check your current credit score

Your credit score determines your approval and the interest rate on your loan, and a higher score can make a significant difference. Real estate lenders often require a score of 720 or higher and a 30% or less debt-to-income ratio.

Check your score before you apply for loans, and fix any errors or other issues that could be causing a lower or inaccurate score. Land loans often have higher interest rates than home loans due to the additional risk of land that has less value and may be harder to sell because it has no completed home on it. Land loans often have shorter terms, from two to five years, with a final balloon payment, increasing the interest rate.

Gather documentation

Lenders will require proof of income, tax returns and information on your pending purchase, such as land survey reports to support the money you want to borrow. Assemble these documents before applying so that you do not hold up the application due to a document that could take a long time to receive.

Keep in mind that lenders may not qualify you for as large of a land loan as a mortgage because of the extra risk involved. Vacant land with no house cannot provide a source of income or an expeditious way to repay the lender if the borrower defaults. Raw land can take much longer to sell than land that contains a finished home.

Calculate the down payment

Land loans often require a down payment ranging from 20% to 50% of the land’s purchase price, so try to have enough capital before you begin the loan process. Lenders also typically give lower loan-to-value (LTV) ratios on land loans than home loans, so your purchase may require a higher down payment.

If, instead of buying raw land, you want to purchase a land parcel that has existing public road access, utilities, survey reports and existing residential zoning, you may get a lower interest rate and a loan term of up to 20 years, which can lower the amount of your required down payment.

Getting a land loan involves the same general process as a regular mortgage loan, but the finer details of each step differ and can add additional cost and complexity. Understanding the difference can increase your chances of qualifying for a loan that meets your needs.