Everything You Need to Know – Lot Loans & Land Loans

When it comes to buying a new home, most consumers have the vision of purchasing a home that is already been constructed, and is already sitting on a nicely sculpted lot or piece of land. The type of loan that you can get for a newly constructed house like this is well-known to most consumers as a home mortgage. But what if you want to purchase a piece of land first, and then build your dream home on it later? What kind of loan is that, and is it different from a traditional mortgage loan?

If you are asking yourself these same questions, and are considering purchasing a piece a land or a lot to build a home on later, you'll need to know the difference between a traditional mortgage loan, a lot loan, and a land loan. A lot or a land loan are both quite different from a regular home mortgage loan (or what some in the financial industry call a "purchase money” loan).

The fact is, conventional home mortgages are structured, underwritten, processed, and accounted for in a very different way than a lot and/or land loan. In fact, an entire marketplace and automated systems have long been set up to make home mortgage loans extremely easy and efficient for banks to underwrite and process.

Understanding the differences between these types of loans is essential if you're considering applying for a land or lot loan. The most fundamental difference is that the banks need to know what specifically your plans are for the land or lot that you wish to purchase.

You see, when you purchase a home that's already been built using a traditional purchase money loan, the bank knows exactly what you're going to use that money to do. You are going purchase an existing home and the land on which it sits.

When it comes to a vacant lot or a piece of land, however, the bank faces much more uncertainty. (If you know anything about banks, you know that they really don’t like uncertainty all that much.)

Because of this, when you are applying for a lot or land loan, you can expect any bank you go to to ask for many more details about the property and your reason for purchasing it. They will need to hear your story in detail before deciding whether to approve your loan or not. In fact, land and lot loans are oftentimes called “story loans" for that very reason.

Bigger Risk for the Bank

From the bank’s point of view, a land or lot loan involves higher risk on their end.

For example, when you purchase a home using a home mortgage, if you default on that mortgage the bank has some pretty good collateral; your home. The likelihood that you will walk away from your home if you have financial problems, or you happen to change your mind about the home you purchased, is also considerably lower.

With a lot or land loan however, it’s much easier for you, the borrower, to walk away from the land or lot, leaving the bank stuck with it. Depending on the location of your particular lot or loan, selling it to another person might be extremely difficult and take years, something that any bank or lender won't be happy about.

For these reasons, the down payment you will need in order to get a lot or land loan, and the interest rates that you'll be paying, are usually much higher than a traditional purchase money loan.

The difference between a Lot and a piece of Land

A common misconception from consumers is that a lot and a piece of land are more or less the same thing. This couldn't be further from the truth.

In most cases, a lot has already been zoned for home construction, has already been professionally surveyed, already has identified property lines and dimensions, and often any easements and access have already been taken care of. In many instances sewers, utilities and streets have already been put in, and other structures as well. That's why a lot is called an improved piece of land. As such, it’s usually ready for new home construction to begin.

Compare that to a piece of land where nothing has been surveyed, access is unknown, and zoning for development has yet to be approved. You can already see a huge difference. This is called an unimproved piece of land. Sewers have not been put in, and streets haven’t been constructed yet (and might not have been laid out even). In fact, a piece of land can sometimes be far from all of those established utilities, making access difficult and costly.

As you can see, there are significant differences between a lot and a piece of land.

Terms and conditions may vary

As a borrower, you’ll find that it is much more difficult to obtain a loan for either a lot or a piece of land and, as mentioned above, the terms will often be less than favorable when compared to a typical home mortgage loan.

These type of loans are similarly structured and documented, but usually have much shorter terms, higher interest rates, and the lender will likely seek additional commitments from the borrower, as well as a stronger underwriting.

Depending on the lender or bank, you may find that they have different terms and programs for lot loans where everything is ready, utilities and roads are already available, and zoning has been completed, than for land loans where the land is still completely undeveloped.

In short, getting approval for land and lot loans is usually more difficult

There are several major differences between a traditional, purchase money home loan, and both a land and a lot loan. It is harder to find a lender, more difficult to get approval, and involves higher interest rates with stricter terms.

These differences exist because of the extra risk that the bank and/or lender takes when approving a lot or land loan. Consumers wishing to be approved for either of the loans should be fully prepared for a more difficult and a lengthy process.