What You Should Know Before Applying for a Land Loan
Most lenders ask for a larger down payment than you would need to get a mortgage loan. It isn’t out of the question to see a requirement of 25 percent down, or more. You may be asked to provide proof of a reserve, guaranteeing that you have money in savings to cover future payments.
Overall, lending standards are usually tighter for buying land. For example, with some lenders, a buyer looking to obtain an FHA mortgage could be approved for financing with a minimum credit score of 500, but expect that to rise to the mid-700s when borrowing for the purchase of land.
You’ll also have a shorter lending term than the standard 15- or 30-year mortgage. Lot loans are likely to only be amortized over a ten- or possibly 15-year span. There are lenders who will amortize the loan evenly over that period of time, while some will seek a large “balloon payment” as you near the end of your term.
Lastly and possibly most importantly: financing doesn’t end with the purchase of a lot. Before you can even think about pouring a foundation, you’ll need to get a construction loan to fund the costs of building your dream domicile.
What is a Construction Loan?
A construction loan is a short-term loan designed to fund expenses related to building your custom home. Here again, the application process is similar to that of a mortgage, but you’ll find a number of differences.
First, you’ll be applying for two loans. One to cover the material costs of construction, and you’ll also need to qualify for a mortgage to convert that temporary construction loan to a permanent one.
How do Construction Loans work?
The way construction loans work is also different from a mortgage. You and your builder will make requests to draw down the loan, during the construction phase, allowing your lender to make periodic disbursements to cover materials and supplies as the project progresses. During this time, you will typically make interest-only payments based on the amount drawn. Once the construction phase is complete, your lender will transition your loan into a regular, “permanent” mortgage to cover the total costs of your custom home.
Since you are applying for more than one loan, you can expect to attend multiple closings. For instance, a buyer purchasing land with no immediate plans to build will require one closing for the lot loan and a separate closing for a construction loan when they enter the building phase.
If you plan to start construction immediately after purchasing land, it is possible to close on the lot purchase and the construction loan simultaneously. In this case, there will still technically be two closings, but they will occur at the same time and place.