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Financing the Purchase of Raw Land & Construction of a Home

Jan 16, 2008
Many people have the idea that it would be great to be able to buy some land and then construct a home on it. However, when someone goes down this path for the first time, they are likely to be in for quite a few surprises. One of the first surprises is likely to be the money issue.

To begin, consider your financing. How much cash do you have? Houses can be purchased with very little cash - 100% financing. This is not possible with land. Banks will loan on land that already has a well on it, and has electricity available at the lot line. If the land does not meet at least this minimum requirement, it will be difficult getting a bank loan. A hard money (private money) loan is possible, but these loans typically require even a higher down payment - perhaps 50%. Another option is owner financing - the owner might take 25% cash down, with 75% of the purchase price held as a debt by you to the owner. Therefore, at a bare minimum, a $200,000 piece of land will typically require at least $50,000 in cash to buy.

No matter the form of your loan - bank, private money, or owner financing - do not expect to get a low-low interest rate as you hear advertised for home mortgages. Expect to pay a couple percentage points higher than a standard 30-year fixed home mortgage from a bank, a bit higher than that from the owner if he provides financing, and four or five percentage points higher still from a hard money lender. For example, if a 30-year fixed-rate home mortgage is 6%, the bank might charge 8% for a land loan, the owner might charge 9%, and the hard money lender 13%.

While you certainly want the lowest rate possible, be aware that this should all be planned as short-term debt. You'll want to pay off the land loan as soon as possible. Before you do this, though, you will need to build a house on the land - finally!

To build, you will likely require a construction loan. Typically, you can get this loan from a bank - and if not, a private-money lender should be happy to loan the money to you - again, at a relatively high interest rate. But again, this too will be a short-term loan.

After you have finished construction of the home on your property, you can refinance the entire property with a normal home mortgage. If you are fortunate, your home will be appraised for a value higher than it has cost you to build - if so, you have made money! If for some reason the home fails to appraise for the amount of debt you now owe on it, you will have to pay down some of that debt with your own cash, before the bank will refinance your debt.
About the Author
This article was written by Seb Frey, a Real Estate Broker and Realtor in Capitola, California (Santa Cruz County). Seb runs the county's most-complete Real Estate web site, SantaCruzHomeBroker.com. Seb is fluent in Spanish, and works with buyers from all walks of life, helping them to buy or sell Santa Cruz real estate.
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