How To Use A Land Loan To Finance A Property Purchase

A land loan can be used to finance everything from a raw plot of land to a vacant lot and construction of a new building. It can be used for land that will host a personal home or a business. Land loans are considered riskier than a mortgage or many other types of loans because:

• Default rates are higher on land loans than home loans. There are many reasons you could default on the loan—maybe construction plans fall through or you run out of money.
• Borrowers are more likely to walk away. If they run into financial trouble, they’ll value saving the home they live in over a piece of land.
• A vacant plot isn’t ideal collateral. If you do fail to make your payments, your unimproved land is less attractive than property that can go to foreclosure auction.

Land loans tend to come with higher interest rates and a higher down payment with stricter credit requirements than other types of property loans because of these risks to the lender.

The terms of your land loan will depend on the type of loan you get, your plans for the land and the particular lender you work with. In general, there are three types of land that lenders will consider financing—raw, vacant and crown land—all of which come with their own pros and cons.

Raw Land

Raw land is land that is undeveloped. There’s no plumbing, electricity or access to nearby roads. Essentially, it’s a blank slate for you to work with. Not surprisingly, raw land tends to be cheaper than developed land, but know that it could cost you more in the long run.

Buying raw land is a risky prospect to lenders, so they often compensate by charging higher interest rates and requiring higher down payments. In fact, you may need to put down 30% to 50% or more if the purchase is speculative, meaning you are hoping property values will rise.

As with most types of loans, a good credit score and solid down payment will help you get approved for a raw land loan and qualify for the best terms. It also helps if your intention is to begin development right away and you have a clear, detailed plan for how you will use the land. Raw land is privately-owned

Vacant Land

Next is vacant land, which is more expensive than raw land, but easier t o develop. Generally, though, vacant land refers to land that is serviced or partially serviced. It has access to some basic utilities like power, water, septic and road services. The land may already be partially developed but is still lacking major items such as an electric meter, phone box or natural gas meter. In other words, there are few added improvements to the plot. Like raw land, it is also privately-owned.

It may be a bit easier to qualify for a vacant land loan over a raw land loan, but it’s still considered risky. Again, you should have a solid credit score, down payment and plan for the land.

Crown Land

Crown land is public land owned by the provincial government. It comes with various restrictions and requirements when it comes to the use of the land. It can be bought outright or rented for specific purposes. Applications to buy crown land are usually evaluated based on whether the use of the land will promote sustainability. Crown land is usually sold at market value, unless the land use will be beneficial to the public. In that case, you might be able to get it for under market value.

Once you’ve saved up a down payment, developed plans for your land and have a solid credit score, it’s time to look around for lenders. Land loans aren’t as easy to come by as mortgages, but you do have several options.

Alternative and Private Lenders

One of the best places to look for a land loan is through a private lender or mortgage brokers who work with alternative lenders.  Alternative and private lenders will have a good idea of how the surrounding land can be used and have more flexibility when it comes to working with customers.

The Canadian Agricultural Loans Act (CALA) Program

The  Canadian Agricultural Loans Act (CALA) Program provides assistance to farmers who need a loan to buy farm land.  In this case the government guarantees lenders who offer CALA loans the repayment of 95% of the net loss on a defaulted loan. Loans are capped at a $500,000 maximum to buy farm land and build or improve buildings on that land and $350,000 for all other eligible loan purpose. For instance, if you’re approved for the smaller $350,000 loan, you can still apply for another $150,000 loan to buy additional farm land or build or improve property on that added farmland.

The Business Development Bank of Canada (BDC)

If you are an entrepreneur looking to start a small business you can purchase land using a commercial real estate loan purchased through the Business Development Bank of Canada. (BDC). The BDC can cover 100% of your costs with payment postponement of up to 36 months and take up to 25 years to pay back the loan. You can also match your payment date to your cash-flow cycle and get additional financing on top of the loan to cover additional expenses, like moving costs. The loan can be used to purchase land or buildings or cover construction costs to build new ones. You can also use it to expand your existing premises or replenish working capital depleted by real estate costs.

Seller Financing

Finally, you may be able to work out a financing deal directly with the person who is selling the plot of land. This option may eliminate the hassle of tracking down a third-party lender and applying for a loan, but an individual seller may want to receive a much larger down payment and be repaid within a couple of years. Be sure that if you do take this route, you get the details of the agreement down on paper and even consult with a lawyer.

Though there are a few different options for financing a land purchase, you don’t necessarily have to go one of those routes. There are also a few financing alternatives that you may find more ideal than a traditional land loan. Before pursuing one of these options, however, it’s important to carefully weigh the risks.

• Home equity loan or line of credit: If you already own property that’s appreciated in value since you purchased it, you may be able to leverage the equity to buy additional land using a home equity line of credit (HELOC) or home equity loan. You won’t have to make a down payment, but this can be a particularly risky option because you could lose your home if you default on the loan.
• Personal loan: Another option is to take out a personal loan, which can be used for just about anything. You may want to consider this option if the loan amount is on the smaller side and/or the land is in a condition that would make it tough to qualify for a traditional land loan. Just keep in mind that because the loan is unsecured, the interest rates can be as high as 30% (especially if you have fair credit).
• Buy a teardown: One workaround to securing an actual mortgage loan for a land purchase is buying a property that you plan to tear down and rebuild. Of course, this option is not without its own potential costs and roadblocks. You’ll need to secure permission from your lender and the appropriate permits, as well as pay for demolition.

If you’re ready to pursue a land loan, one of the best places to start is your own backyard. Local lenders will have the ability to assess the land and its potential, as well as the flexibility to offer better terms. You can also turn to the web. Online lenders have little overhead, which means they can pass on those savings to you in the form of lower rates and fewer fees.

Whichever lender you choose, be sure to spend time evaluating all of your options and crunching the numbers. There may be many options for securing a land loan, but many aren’t cheap.