Lot loans: everything you need to know

May 31, 2019 - 5 min read

Lot loans come in many forms

Lot loans are mortgages for lots. Not “lots of money,” but financing for a parcel of land on which you want to build a home. There may be a number of paths open to you. And you need to pick the one that’s smoothest for your particular needs.

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Raw land vs. lot land

But before we explore those paths, let’s differentiate between “raw land” and “lot land.” People define these in different ways.

  • Raw land is just land. which may or may not be suitable for development
  • Lot land is intended for residential development, and likely to have at least some of the following:
    • A building permit or perhaps appropriate zoning
    • A survey report with stakes denoting the site’s boundaries
    • Access across public roads OR rights to access through a permanent easement
    • Utilities on site or nearby, such as mains water, electricity and perhaps natural gas
    • Access to a public sewer or a viable option of providing a private alternative

Getting a mortgage for a manufactured home

Borrowing for a lot is typically much easier than getting a loan for raw land. Expect to make a bigger down payment (up to 50 percent) and pay a higher interest rate if you want the latter. Some lenders want to treat these as commercial loans, so be sure to familiarize yourself with how these work if you’re used only to residential mortgages.

Why borrowing for lot land gets complicated

In one classic scenario, you may find yourself needing three mortgages:

  • One to buy the land
  • Another for construction
  • The third to consolidate (pay off) the first two, so you end up with a single, nice, normal home loan. That’s also called “permanent” or “take-out” financing

Clearly, three mortgages involve a huge administrative burden and three hits from closing costs.

Crazy mortgage programs that really exist

But it’s possible you’ll qualify for a federal government program or one run by Fannie Mae or Freddie Mac that could streamline that borrowing. More about those below.

If you’re unable or unwilling to participate in those programs, you may have other choices

Ways to borrow without Fannie, Freddie or the government

You may be able to reduce your administrative burden and closing costs by using alternative borrowing sources. You’ll find this much easier if you have a good credit score, assets, savings, or equity in your existing home, and can easily afford the new loan’s payments.

Using home equity

If you’ve built up substantial equity (the amount by which your home’s current market value exceeds your mortgage balance) in your existing home, you may be able to use that to finance the purchase of your lot.

What's better? HELOC or home equity loan?

Such borrowing comes in the form of a home equity loan, so you still have some closing costs. But these are typically less than on a first mortgage. You have two main choices:

Home equity loan

You borrow a lump sum and make equal monthly payments over the term. Interest rates are often fixed. If you intend to repay the loan from a mortgage on your new home, make sure there are no onerous early payment penalties.

Home equity line of credit (HELOC)

These are a bit like credit cards (though with much, much lower interest rates), in that you are given a credit limit and can borrow and repay at will up to that amount. You only pay interest on outstanding balances, and rates are often variable.

This might be just the flexibility you need when buying a lot and, perhaps, financing some or all of the construction.

A personal loan

Personal loans are on the rise. They are not attached to any property, but your credit history and borrower profile. You can use funds for just about any purpose, including buying raw land.

Loan amounts go up to $100,000, and approvals typically happen faster than for property loans.

Seller financing

If the current owner of the lot is keen to sell, he, she or it may be willing to lend you the purchase price, usually with a down payment. It will help if you already have financing lined up to cover construction and a way to repay the seller’s loan.

Rent-to-own homes: Move in now, buy later

Although this will normally be a mortgage secured by the land, it will typically be subject to few rules or regulations. Sometimes, lawyers are not involved, and costs and admin can be very low. However, if you decide not to use an attorney, you need to be extremely careful about what you sign.

Conventional bank loan

You may find that a bank will be willing to lend you what you need to buy the lot. It may be willing to advance you the construction costs, too.

Expect to have

  • Great credit history
  • Sufficient income or resources to cover loan payments until you refinance the home with a traditional mortgage
  • Credible plans and cost estimates, if you want to borrow for the construction phase

Freddie and Fannie

Freddie Mac and Fannie Mae both have “construction conversion mortgages.” These allow you to wrap up your lot-purchase and construction borrowing within a single, permanent mortgage.

You may also be able to have a “single-closing transaction“ that lets you borrow your construction costs upfront. The contractor will then receive stage payments as each phase of construction is completed and verified.

Federal government programs

Several government agencies offer programs that may be able to help you, providing you qualify for assistance:

FHA 203(k) rehab mortgage

As the name implies, the Federal Housing Administration’s 203(k) rehab mortgages are intended for the construction or rehabilitation (and purchase) of existing homes.

The U.S. Department of Housing and Urban Development says, “A home that has been demolished or will be razed as part of rehabilitation is eligible, for example, provided that the existing foundation system remains in place.”

FHA 203k Loan – Rehab Loan Benefits, And Some Downsides

USDA loans

The United States Department of Agriculture and Rural Development has a program for those with modest incomes buying or building in rural and semi-rural areas. You can check your eligibility and that of the lot you want to buy on the USDA’s website.

Per the USDA, “Funds can be used to build, repair, renovate or relocate a home, or to purchase and prepare sites, including providing water and sewage facilities.”

The best thing about USDA loans is that you may be able to get one with a zero down payment.

What is a USDA Loan? Eligibility, Rates & Downsides

VA loans

If qualify, you may be able to finance your lot purchase and construction within a single loan — with no down payment.

However, it can be difficult to find lenders and contractors who are willing to jump through the program’s hoops. So you may need to persevere to achieve your dream.

VA Mortgage Rates & 10 Terrific Reasons To Use A VA Loan

Perseverance is all

It’s not just with VA construction loans that you may need to persevere. Financing and building your own home can be challenging. Such projects are not for the fainthearted.

But, as with many difficult things, the rewards can be life changing.

What are today’s mortgage rates?

Rates for most “one time close” mortgages are about the same as mortgage rates for traditional mortgage programs. However, administrative costs can be higher because the lender requires title companies and appraisers to verify that the construction is progressing before they release funds.

For the best mortgage rates, compare programs from several competing lenders before you commit.

Time to make a move? Let us find the right mortgage for you

Peter Warden
Authored By: Peter Warden
The Mortgage Reports Editor
Peter Warden has been writing for a decade about mortgages, personal finance, credit cards, and insurance. His work has appeared across a wide range of media. He lives in a small town with his partner of 25 years.