Having identified a parcel of vacant land -- and negotiated a purchase contract with the seller -- the investor in raw land is now at the point where financing becomes the issue. There are a number of different options regarding getting the money necessary to acquire the property on which to build a house. However, buyers must consider the cash flow of their business or household while taking an accurate measure of their assets. A finance strategy that makes sense will vary from person to person. In this post, we look at the options available and how they will work.
A land loan differs from a home mortgage in that the collateral does not include any structure. In addition, there are not any "no money down" products in this category of real estate financing. While this does resemble a traditional mortgage in that you pay it back over time with interest, it is more hazardous to extend for lenders, who will demand a higher threshold of acceptable credit scores, e.g. above 700 FICO score. Most challenging for banks and finance companies is the task of evaluating the applicant's plans for improving the vacant land.
One way to increase the lender's confidence level is to present a detailed plan where building begins right after the land is conveyed. For this to happen, of course, the land needs to be in condition for building and it must be zoned appropriately. Another plus for lending institutions is when the United States Department of Agriculture (USDA) or other government agency guarantees the loan -- USDA home loans are designated for specified rural areas. As you look at various lenders, do not discount local community banks or credit unions: these organizations are generally more willing to offer land loans than the nationwide mammoth banks.
Cash Is King
An old adage in real estate says that "cash is king." This means that you go into a transaction in a stronger position if you have the money to pay for the property without having to borrow any. Why does this matter? The advantages of an all-cash deal are several:
- Sellers are more open to a lower price with cash-only offers.
- Closings happen faster since there is no lender acting as a third party.
- There are fewer attorneys, appraisers and other vendors with all-cash conveying.
Still, paying for property out of your own assets means those assets are diminished when the cash is spent. Also, if you plan to buy more land for future homes, you may want to conserve your own funds if a land loan is readily available.
Here is an alternative where a buyer can sidestep a lender and pay the seller in installments. Using an attorney is best because you will negotiate terms of the financing such as interest rate, loan term, payment of taxes and other matters without any regulatory constraints imposed on banks and mortgage companies.
Finance against Other Collateral
Building a house on vacant land raises many question marks for traditional lenders, especially in terms of home value after development. Those same banks, however, should have no problem refinancing your primary residence, secondary residence or investment properties you may already hold in your portfolio. Proceeds from these cash-out deals can go to the raw land purchase, cash flow permitting.
Of course, any discussion of home value is premature if the land is outside a residentially zoned area. The next blog post will look at zoning and variances relative to vacant land buys.