You’d like to build your own home, and have found the ideal parcel of land at a reasonable price. Then comes the matter of how to pay for it. If you can’t – or don’t want to – pay cash for the full price of the land, you’ll need to finance some or all of the purchase price. How do you qualify for a loan to buy the land?
There are many ways to finance the purchase of vacant or undeveloped land. The most common are seller financing, bank financing, or an equity loan or equity line of credit secured by your existing home. Here are some suggestions about how to qualify for them.
A seller of vacant land – especially one who is highly motivated to sell – may be willing to provide financing (purchase money financing) to a qualified buyer, for some or even all of the purchase price. Here, “qualified” means any criteria that will satisfy the seller that you can be counted on to repay the loan.
Since the seller has already determined the market value of the land, you won’t need to obtain an independent valuation in order to confirm its worth as collateral for the loan. The seller may not ask for anything more than a mortgage on the land, but you should be prepared to demonstrate that you have good credit (for instance, your credit scores and evidence of credit history, or letters of recommendation from banks, tradespeople, or anyone else who has extended credit to you in the past), and that you will be able to repay the loan when it comes due (such as tax returns or W-2 statements of income sufficient to pay for the periodic interest on the loan).
Because the land itself won’t generate the income required to pay off the loan, a construction-financing commitment from the bank to cover building your new home will be very helpful.
A lawyer can be worth bringing in – for both you and the seller. You’ll both want to be sure that basic terms, like price, term, interest rate, and when and how payments of interest are to be made, are included in the promissory note. The mortgage, which secures the note with the land, will be recorded; you’ll want to take particular care with the description of the premises, event of default, and other standard mortgage terms.
Qualifying for bank financing for the purchase of vacant land usually calls for the buyer to show excellent credit, income sufficient to pay for the interest that the bank will charge for the loan so long as it is outstanding, an appraised market value for the land that exceeds the principal amount of the loan, and a plan to pay off the loan.
You will need to provide the bank with evidence of income (such as tax returns, W-2 statements, and the like) that meets the bank’s income-to-loan ratio (your total monthly debt payments, including the interest on the new bank loan, divided by your monthly pre-tax income, typically 30% to 40%). The bank will obtain (and you will pay for) copies of your credit score and history and an appraisal of the land.
If you will be seeking construction financing from the same bank, the bank will also, at the same time, ask for engineered construction plans and detailed construction cost estimates.
If you will be obtaining your construction financing from a different bank, or if you don’t have immediate plans to build a house, the bank that is providing the financing for your land purchase will probably expect an even better credit record and history and ask for a lower income–to-loan ratio (it will want more collateral for every dollar you intend to borrow).
If you already own a home, and if, over time, you’ve been able to build up some equity (either by paying off your mortgage or because the property has appreciated in value), consider an equity loan or equity line of credit as a source of financing for the vacant land you want to purchase.
Your bank’s lending requirements are likely to be less onerous than if you were applying for a construction loan or for permanent (long-term) financing for a new home; your bank has already determined your creditworthiness and appraised the value of your existing home when you first bought it.
Expect the bank to ask you to update your credit and income documentation (recent tax returns, W-2 statements, and so forth). As with new financing, the bank will likely look for an income-to-loan ratio of 30% to 40%.