Buying Land vs. Buying a House: The Differences Are Stark!
Planning on buying land to build your dream home? Make sure that you know how to finance it!
My husband and I love our house. We’ve invested tons of sweat equity into the place – everything from landscaping and new flooring to swapping out every single piece of trim and all of the doors. But it’s small, and considering that we’re planning to start a family in a few years, we’ll need to move into a larger home.
My husband and I plan ahead, so we began exploring our options. We didn’t like the bigger houses that we saw in the area, so we explored an addition to our current home. We abandoned that option, too. That’s when we began to mull over the idea of buying land to build a house on. There were three reasons why we settled on the land option:
First, we’re comfortable in our home, so we’re in no hurry to move. Second, the available homes we saw didn’t fit our needs. And third, we crunched the numbers, and buying land made perfect financial sense. We could pay off the entire parcel in just a few years while staying where we are, and then build the exact house we want.
So, we found the perfect lot and then started in on the overwhelming amount of paperwork to purchase it. In all honesty, we had assumed the process would be seamless and stress-free. We had already gone through all of the hullaballoo involved in getting a mortgage, so how much different could this be?
We went into the process of buying land thinking that we were experts who knew everything we needed to know. Boy, were we wrong.
Here are four key things we learned about land loans in the process of buying land to build a house:
1. They’re Structured Differently
There are a few different structures you can choose for a mortgage. But there are much fewer options with land loans, and they’re structured quite differently than loans for a house.
The majority of land loans are done on three- to five-year balloons. This means that the entire balance needs to be paid in full within those three to five years (or, alternatively, the loan must be refinanced).
Admittedly, the concept of a balloon loan made us nervous. But we did our research, spoke with our banker, and ended up feeling reassured enough to move forward. We also adjusted our budget to ensure that we could comfortably pay the loan off within five years.
2. The Requirements are Different
Ready for a rude awakening? Both down payments and interest scores are higher for land loans (more on that later). With many lenders, down payment requirements can range from 20 to 50 percent in order to secure financing to purchase land.
Fortunately, things were a little different with our bank. As long as we had a credit score of over 780, we qualified to make a down payment of just 10 percent. Of course, as credit scores go down, the percent you need to put down on the land goes up.
To put it simply, qualifying for a land loan is quite different from a traditional mortgage. So make sure to have frank conversations with your banker. You can also use companies like CreditSesame to check your credit score for free.
3. It Can Count as Our Down Payment for a Construction Loan
While we don’t plan to build on our land for a few years (once the loan is completely paid off), we’re already planning on how we’ll make a down payment on a construction loan to build our new home.
As it turns out, the amount we pay on the land counts toward a down payment on a construction loan.
When we’re ready to secure one, an appraiser will come out and assess the value of our land. That value — minus the amount we still owe on the land (which will hopefully be nothing by then) — counts as a down payment on our construction loan.
While we still plan to save even more so that we can make a large down payment and secure a good interest rate, it’s nice to know that the money we’re paying for the land now will also help us when it’s time to build.
4. Land Loans are Riskier for the Lender
Why are down payment amounts and interest rates higher for land loans? Because they’re much riskier for the lender. Considering that the loan’s only collateral is vacant land (as opposed to a house), it’s much easier for the owner to simply walk away, leaving the lender stuck with land that isn’t easy to get rid of.
We learned that this meant we had quite a bit less wiggle room in terms of finding a lower interest rate. But in the end, we were still happy with where we ended up.
Just remember that buying land is very different from buying a house. We are glad we asked the right questions before making the decision. Now all that’s left to do is pay off the land and build our dream home!