Construction Loan vs. Land Loan: Which is Right For You

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Comparing Constructions Loans to Land Loans

Are you planning on purchasing a plot of land and custom building a home? You may have wondered what kind of mortgage should you be considering.

Should you go with one of the loans for construction or does it make more sense to choose land loan financing. Before delving into this greater it is essential to note that a construction loan is used to finance the purchase, construction, improvement, or alteration of real property.

A land loan is used to finance the purchase of land, developmental land, or any other type of property. Figuring out what differentiates these two types of loans and which makes the most sense to choose is paramount.

Let's go over what you need to know about construction and land loans to help you make an informed decision.

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Construction loan vs land loanDeposit Photos

Getting a Construction Loan Makes Sense When You're Ready to Build

When you know that you have an immediate time frame to build your dream home, a construction loan makes the most sense.

The beauty of this kind of financing is the lender will give you a mortgage for the acquisition of the land and the construction of the house all in one loan.

It works similarly to buying a traditional re-sale home in regards to the paperwork the lender will require. However, there will be a few more items you will need to include in order for the lender to approve the loan.

Some of the items needed for a home building loan include detailed blueprints of what you plan to build, a detailed of the cost to complete the project, specifications on how the home will be constructed and the builders license/qualifications.

When you get approved for the loan, the lender will want a schedule of payments to finance the project. These payments are referred to as "draws". The lender does not give you a lump sump of money all at once but payments as the project moves along.

For example, when the lot is cleared, the foundation whole is dug, and the foundation is installed, the lender will give you part of your mortgage. These monies are then used to pay the subcontractors performing their work.

Construction loan lenders will send out a representative to ensure the work has been completed before they will release the money.

The next draw will happen when the framing of the house is completed. Each significant phase of construction will have a draw until construction is complete.

With construction loans, you need to put down at least 20% of the total purchase price. This is more significant for construction financing than for other loan types.

Select lenders provide construction loan financing, which means that you will need to compare the terms and fees of various lenders before choosing one.

Speaking to multiple lenders about your home construction loan exposure is a good idea if you want to get the best possible terms for your home purchase. Maximum Real Estate Exposure has put together an informative guide on the subject, which can help you make informed decisions.

Land Loan Financing is Better Suited For Longer Term Projects

When you are not ready to build your home right away, a land loan will be more suitable. Maybe you are not even sure what you want to build? You have seen the perfect piece of land though and you don't want to let it go.

Land is hard to find and it fits what you're looking for perfectly. This is where loans for land work in your favor. However, before venturing out to get a land loan, there are some essential things to know.

Land loans are more challenging to get. Not every lender who does home loan financing also does land loans. Some of the best options for a land mortgage include credit unions and community banks. You should start in these places first.

You can expect that the interest rate on your land loan will be higher and the down payment amount will be more significant too. More than likely, you will need to plan on putting 25-30 percent down.

The land is going to be scrutinized closely by the lender. For example, is the home ready to build on? Can you walk into the local building department and pull a permit?

Land lenders are going to be much less committed to giving you a land loan on a property that is not approved. Usually, when the land has no improvements nearby such as roads and utilities only a developer will be able to get land loan financing.

The common person not experienced in land development will typically be out of luck.

Be ready for the bank to establish how far along the property is in terms of approvals. Is the lot ready to go or is it undeveloped?

Final Thoughts

Both land loans and constructions loans are excellent options depending on the timeline of your project. If you're ready to go, you can jump right into a home construction loan. If not, a land loan will serve you better.

In either case, make sure you do proper due diligence. Ask the lenders lots of questions and get yourself comfortable with the loan process.

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Bill Gassett is an avid writer for numerous real estate topics including finance, mortgages, moving, home improvement, and general real estate. His work has been featured on numerous prestigious real estate publications.

Massachusetts State
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