With the limited supply of houses available, more and more people are considering buying land and building a home. I have had about 5 clients this year alone bring up wanting to do this which is more than all other years combined.
Building can be a great route for the right person and situation, but it comes with different challenges. You do not just get a typical mortgage and call it a day.
In this blog post I am going to walk you through the various loan options you have.
But before I get into it, let me caution you to take this process slow. Way too many people decide they want to do this, they find the land, then they buy it.
This is not what you want to do.
Before you commit to that loan, you also want to be meeting with a builder to price out the house. The last thing you want to happen is you buy the land and the house costs way more than you thought and you feel stuck.
This is a big, big decision. Take the necessary steps to make sure it is the right decision and will work for you.
Anyways, let’s get into the different loan options/ways you can pay for the property.
Land loans are a form of financing that can be used to purchase a plot of land. They tend to be harder to qualify for and obtain since there is no home that can be used as collateral. They typically require you to put down a larger amount (anywhere from 20-50% down) as well as come with a higher interest rate since there are less competitors in this space.
If you get approved, the lender will give the funds to the seller and you will repay with interest over a set period of time. Some even are structured as balloon mortgages, with interest-only or even no payments for a set of time with a large one time payment coming due sometime in the future. You definitely need to prepare for something like that as it could require a lot of cash or a new loan for it to roll into.
Construction loans are the most common for option I see used for this situation.
A construction loan is a short term loan that covers the cost of buying the land and building a home. You use the funds to pay for pretty much everything from the land, to the construction materials.
Once the home is built, you will then convert the construction loan in a mortgage. With construction loans, you can expect to need a minimum of 20% down.
Typically, a construction loans come with variable interest rates which can hurt if you are building through a period like the last few years since the rate is changing often. When the place is being built, you often pay interest only on the loan.
But be careful with this, you run the risk of interest rates being way higher once the build is done and you need to get a mortgage.
Many people who built in the past 2 years knows how tough of a situation this can be if you finish your home and rates are a couple percent higher. For some, it has caused the house to be affordable.
If you are not able to qualify or find a lot loan or construction loan, some choose to go the route of a personal loan. I would say this is less common, but it can be considered.
Personal loans are offered by banks, credit unions, etc. and you can use these funds for really whatever you want. But they also typically have higher interest rates than mortgages. With a personal loan, they are unsecured, meaning there are no collateral requirements.
You also can expect a shorter repayment term which means way higher payments.
An alternative to the options above is to create a contract to purchase the land directly from the seller vs using a lender. You basically just make payments on the land until the loan is paid off. However, you still need to find financing for the building of the house.
You can typically get more flexible terms here since it is between you and the seller and not a bank. But this does not always work out as they may not want to have to deal with waiting on the full amount.
Understand that a lot of these options carry risk as you won’t get the mortgage until the build is done. I have seen this put many people get themselves in a tough situation as they built based on 3% rates and now they are facing a 7%+ mortgage.
That is a huge difference in monthly cost and what you can afford.
Please, please, please, take your time and map this all our before starting the process. It is never wise to rush into huge decisions.
Disclaimer: None of this should be seen as advice. This is all for informational purposes. Consult your legal, tax , and financial team before making any changes to your financial plan.
Financial Advisor