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Given the current shortage of housing inventory, many would-be homeowners are thinking harder about buying land and building a house on it. But purchasing a parcel for new construction isn’t as straightforward as purchasing an existing home, especially when it comes to financing. While a regular mortgage is not an option, there are loans that can help cover the cost of a land purchase, including a home equity loan.
Let’s talk about how to buy land using home equity.
Source: U.S. Census Bureau & U.S. Department of Housing and Urban Development
When you take out a home equity loan, also known as a second mortgage, you’re borrowing money against the equity you’ve built up in your current home. That means that your home is collateral for the loan. If you don’t repay it, you could lose your home to foreclosure — a risk not to take lightly.
You can use the funds from a home equity loan for any purpose: buying the land, hiring an architect, engaging a general contractor. Depending on the loan term, you might have as much as 30 years to repay the debt with interest, similar to a 30-year mortgage for a home purchase.
Another option is to use a home equity line of credit (HELOC). Using a HELOC to buy land also means borrowing against the equity in your house, but instead of a lump sum, you get a revolving line of credit — one that refreshes as you pay back what you borrow. This could allow you to borrow to buy the land, repay that sum, and then borrow again to fund the actual construction, for example. You could even buy the land with cash, wait until you accrue enough equity in your home, and then use that to establish a HELOC to develop the property.
If you want a lump sum to work with, though, skip the HELOC and pursue the home equity loan to buy land.
Before using home equity to buy land, consider what you’ll use the land for. Residential land sales represent about one-quarter (24 percent) of all U.S. land sales overall, but can approach close to half (42 percent) in some regions, like the southern East Coast, according to the latest “Land Market Survey” by the National Association of Realtors and Realtors Land Institute, released this past March.
Then there’s the value of the land itself. As noted by the U.S. Bureau of Economic Analysis, land values vary drastically across the U.S. depending on location (for example, rural versus urban), proximity to facilities, local market conditions and other factors. Those looking to build a home are likely looking for developed or improved land that’s already connected to main utilities and roads. Developed land is generally more costly than raw land.
Finally, there’s how much money you need. Many other expenses exist beyond the price tag of the land, including a land survey and title search. And of course, the costs to build a home once you’ve purchased the land it’ll sit on.
All of these can be paid for with a home equity loan, but you’d need a substantial ownership stake to cover everything involved in the land purchase and construction. And don’t forget the maximum you can borrow with a home equity loan is typically no more than 85 percent of your equity (sometimes just 80 percent). It might not be enough, in other words.
The highest land value per acre is in New Jersey. The lowest is in Wyoming.
Land can be a good investment. If you’re buying the parcel next to your current home, that added space can help you sell your property for more dollars down the line. You might also qualify for a tax deduction on the home equity loan interest, especially if you use the land to enlarge your home or add new structures or facilities — things that arguably improve the property value.
But if you buy a parcel way out in the middle of nowhere that isn’t hooked up to utilities, you’ll need to spend quite a bit of money before that land is usable. The more you have to spend, the more it eats into your return on investment.
Ultimately, this is a decision you should weigh carefully. Don’t act on it unless you have a clear use case for the land — especially if you’ll be using a home equity loan, which means putting your current residence on the line.
No: A mortgage has to be secured by an existing residential property on the land. That’s why people have to explore other lending options when they want to buy land without a home on it.
A home equity loan isn’t the only option for buying land. Consider these alternatives:
Construction loans are short-term loans meant for those building a new home. The loan can be used for various project-related expenses, including land, permits, materials and labor.
Typically, you draw down funds from the loan as needed as the project moves along and meets certain milestones, then convert it to a permanent loan and repay it similarly to a traditional mortgage. To qualify, you’ll need to provide the construction loan lender with a project plan that includes your budget and timeline, in addition to making a significant down payment or having other assets in the bank.
Some people buy land and wait to build equity in it. Once they have enough, they use the equity in land for construction loan collateral.
As their name implies, land loans help borrowers buy raw or undeveloped lots or parcels. They aren’t as common as construction loans and, depending on how the loan is structured, may dictate a hefty down payment and a shorter repayment period.
Also, the Federal Deposit Insurance Corporation (FDIC) sets limits on how much financing a lender can extend on a lot or piece of land, ranging from 65 percent to 85 percent. Going by its guidelines, the minimum down payments on different types of land would be:
Of course, individual lenders might demand even higher down payments. You also might need to put up your home as collateral or demonstrate that the property meets the appropriate zoning and land-use requirements.
Personal loans max out at a lower dollar amount than home, construction and land loans, and tend to carry higher interest rates. But if you have your eye on an affordable parcel, this could be an option. With a personal loan, you can use the loan proceeds however you want.
A land equity loan may be an option worth considering if you already own a piece of earth and want to buy more — or to improve on what you have.
Where a home equity loan uses the home’s equity as collateral, a land equity loan uses the land’s equity as collateral. Using land to back the debt often affords you the option of lower interest rates and longer loan repayment terms than land loans do.
Another benefit of a land equity loan is that you don’t have to tie up other assets like your home. But of course, you’re in effect mortgaging the land. It’s the same principle, just on a different asset.
There are land equity lines of credit too, similar to HELOCs. With both, you can only borrow against the portion of land you own outright.
Borrowing money to buy land comes with risks, especially if you’re putting your home on the line with a home equity loan. If that’s the case with you, consider whether a home equity loan is the best form of financing to make your land purchase happen.
Begin by comparing home equity loan rates and explore whether cash or a construction, land or personal loan might be a better fit.
