Lot and Construction Loans: What You Need to Know

The world of home financing can be oh-so-confusing, especially when you are looking to buy a lot and build a custom home. In this article, we look at the types of loans available and help you figure out which one is best for your circumstances. On top of that, we outline what you’ll need to get pre-approval for the kind of loan you want. Let’s get started!

Lot or Land Loans

If you have already found the piece of land you want to buy and know that it will be several years before you start building, a lot or land loan is the best option. Actually, the best option is to pay cash since obtaining this kind of loan can be difficult and have unfavorable terms, but sometimes it is necessary to go this route. Be prepared to see shorter-term loans, higher down payments (around 30 percent), higher interest rates and additional borrower commitments and underwriting.

“Owners of raw land are much more likely to stop making payments and walk away from the property in the event of a financial event in their lives,” says Casey Fleming, a mortgage adviser with C2 Financial Corporation.“And land is much harder to sell [than a home].”Many lenders do not even offer lot loans, and community banks and local credit unions can be a better bet than large national banks. As with any loan, be sure to shop around so you can compare all of the offers available to you.

Construction Loans

When you are ready to build on already purchased land or if you want to buy a lot and build right away, you will need to apply for a construction loan. If you already own the land, the equity can be used as collateral to help finance a construction loan, or you may also be able to use a current home as collateral.

Sidney Potter, owner of Potter Equities and author of The Flip, suggests finding “a very experienced construction loan broker; they are a slightly different breed from typical mortgage loan officers because they specialize in this area.”

Two kinds of construction loans are generally available to borrowers:

Standard Short-Term

This type of loan structure used to be the primary way to finance building a custom home. Two loans were necessary: a short-term construction loan for the construction phase, followed by a long-term “end loan” to pay off the construction loan. Essentially, you refinance the construction loan and enter into a new loan (aka mortgage) for the completed home. In other words, you undergo two closings and risk receiving unfavorable terms for the second loan due to rising interest rates. Potential benefits include lower rates (but this is not guaranteed) and more flexibility since you can pick and choose rather than go with a package loan deal. While this type of loan scenario is still possible, lenders have developed another solution for borrowers known as “construction-to-permanent,” “single close,” or “all-in-one” loans.
 

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