What property buyers should know about land loans

If you're thinking about buying land, you'll be hard-pressed to persuade a mortgage lender to finance your purchase. Instead, you'll likely need to apply for a land loan.

Land loans aren't as common as mortgage loans, so your options may be limited. Also, because of different factors, you could end up with a shorter repayment period and higher down payment and interest rate than you'd find with a mortgage loan.

Land loans are a type of credit you can use to buy a vacant lot to eventually build a home on or raw land that you don't intend to develop.

Land loans tend to be riskier for lenders than mortgage loans, according to Casey Fleming, a mortgage adviser with C2 Financial Corp. in San Jose, Calif. Because of that, you may not get terms as favorable as with a mortgage loan.

"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," Fleming said. "And land is much harder to sell" than a home.

That's primarily because demand for land is smaller than demand for new and existing homes. So, if a lender needs to foreclose on the land, there's no guarantee it will get its money back in a timely manner — if at all.

As a result, some lenders require a substantial down payment and charge high interest rates on land loans. Also, some land loans have significantly shorter repayment terms than a typical 15- or 30-year mortgage loan term.

1. Lender land loans

Community banks and credit unions are more likely to offer land loans than large national banks. Your best bet is to find a lender with a presence near the land you want to buy. Local financial institutions know the area and can better assess land value and potential.

If you're leaving the land undeveloped, interest costs will be very high, Fleming said. Plus, a lender could require a down payment as high as 50 percent.

Some lenders, however, may be willing to take a lower down payment and charge lower interest rates if you have plans to build soon. So, shop around before you apply.

Also, local lenders are more likely to offer longer repayment terms, giving you more time to repay the debt.

2. USDA Rural Housing Site Loans

If you're planning to build a primary residence in a rural area, the U.S. Department of Agriculture (USDA) has a couple of loans that can help. Section 523 loans are designed for borrowers who plan to build their own home, while Section 524 loans allow you to hire a contractor to build the home for you.

Both loans are designed for families with low to moderate income, and they have a repayment term of just two years. Interest rates, however, can be low. Section 523 loans, for instance, charge just 3 percent, while Section 524 loans charge the current market rate.

Depending on the situation, you may even qualify for a loan with no down payment.

3. SBA 504 Loan

If you're a business owner planning to use the land for your business, you may qualify for a 504 loan through the U.S. Small Business Administration (SBA).

With a 504 loan, you, the SBA and a lender help contribute to the costs of the land purchase:

SBA loans come with a 10- or 20-year repayment period. Terms vary by lender.

4. Home equity loan

If you have an existing home with significant equity, it may be worth getting a home equity loan, which has no down payment, instead of a land loan.You can typically get a low interest rate — regardless of what you plan to do with the land — because your home secures the loan.

The downside is that if you default on the loan, you could lose your home. Also, since you're not using the loan to buy, build, or substantially improve the home used as collateral, you can't deduct the interest from your taxes.

5. Seller financing

In some cases, the person or company selling the land may be willing to offer short-term financing. With a seller loan, however, you can typically expect high interest rates and a high down payment. Also, it's unlikely you'll get a long repayment term.