If you are seeking to buy a car, a house or just about any other large purchase, loans can make the difference between obtaining the item in question or not. In some situations, however, conventional loans may be less equipped to accommodate the risk present in a transaction. For example, many lenders will not allow individuals to purchase land with a conventional loan. This is primarily due to the fact that there is very little collateral that can be put up by the borrower to match the value of the land in question.
Although buying land with a conventional loan is possible, it is also somewhat rare. This is because there is no available collateral that individuals can offer up to match their purchase, thus creating unnecessary risk for the lender.
The Basics of Conventional Loans
When a lender refers to a conventional loan, they are typically speaking about a mortgage-backed loan, such as the type you would use when purchasing a home. These loans are not backed by a federal agency, as is common with Federal Housing Administration loans, Veterans Affairs loans and U.S. Department of Agriculture Rural Housing Service loans. Instead, conventional loans are offered by either private organizations, such as major retail banks across the country, or one of two government-sponsored organizations, those being the Federal Home Loan Mortgage Association, or Freddie Mac, and the Federal National Mortgage Association, referred to as Fannie Mae.
Although government mortgages such as FHA and VA loans are quite popular and used frequently by those who qualify for them, conventional loans account for the vast majority of loans offered to borrowers today. In fact, about two-thirds of loans issued to borrowers are conventional loans.
Understanding the Conventional Loan Process
In order to qualify for a conventional loan, borrowers must first meet the borrowing standards established by the private lenders. Given the fact that the majority of these loans are not overseen by federal government agencies, private lenders can establish their own criteria for determining loan eligibility among borrowers.
Generally speaking, all borrowers who are seeking approval for a conventional loan must not only complete the application for the loan but also supply a wide array of supporting data that proves they match the profile of a low-risk borrower as dictated by the lender. In the vast majority of situations, the credit score and debt profile of a potential borrower will be taken into account when assessing their loan eligibility.
Other items commonly presented in support of a conventional loan application include extensive proof of income, full employment verification and a detailed survey of current assets. Proof of income could take a variety of forms, ranging from recent pay stubs from an employer to multiple years of federal tax returns. As a general rule, individuals who are self-employed will likely be required to offer up more exhaustive documentation to successfully prove that their source of income is stable and sufficient to cover the cost of the mortgage.
Loans and Employment Verification
It is common for mortgage lenders to contact a potential borrower's listed employer in order to ensure that they do, indeed, work there. While this may seem like an excessive invasion of privacy to some, it is important to remember that agreeing to loan funds to a borrower presents its own fair share of risk. The lender needs to be fully assured that the borrower will not default, as this could result in serious financial problems for them over time.
Again, the point should be mentioned that self-employed borrowers will typically be required to provide a wider array of documentation at this stage in order to fully prove that they maintain a stable source of income.
Other Documentation Requirements
Regardless of what type of loan you may be seeking out, it is almost guaranteed that you will need to provide the potential lender with a valid driver's license or other state ID. Additionally, the lender will need your Social Security number in order to run a credit report on you. Without a credit report, there is essentially zero chance that you will be approved for a conventional loan.
As a general rule, individuals who are applying for a conventional loan will spend a substantial amount of time prior to applying for their funds collecting all of the necessary documentation in order to ensure that no problems arise during the actual application process.
Conventional Loans and Interest Rates
In many situations, conventional loan providers will dictate a "cutoff point" with regards to credit scores and borrowing history, at which point financing will not be offered. That being said, lenders may tweak the terms of borrowing as a potential borrower's financial profile approaches the "no-go" zones they have established. For example, a lender may choose to offer a significantly higher interest rate for an individual whose credit score falls below a certain level rather than denying them access to funding entirely.
Similarly, individuals who have a high level of pre-existing debt may still be given access to funding, albeit with a larger initial down payment on their purchase. Private lenders have a significant degree of flexibility when it comes to making offers to borrowers. As long as the individual in question hasn't completely exceeded the risk thresholds established by the lender, a deal can still be made.
Conventional Land Loans and Other Options
When it comes to borrowing money to buy land, the specific parameters associated with loans can change entirely. Land loans are grouped into five distinct categories, those being:
- Lender land loans
- USDA Rural Housing Site Loans
- An SBA 504 Loan
- A home equity loan
- Individual seller financing
Fundamentally, these loans can be distinguished from one another based on who is offering the financing and the repayment terms attached to the funds in question. The conventional loans mentioned previously broadly qualify as the lender land loans mentioned here.
A USDA Rural Housing Site Loan, while not explicitly designed for the purchase of the land, is nevertheless quite valuable for those who do plan on using their land purchase as space for a new home. This particular program offers low interest rate loans to individuals who are planning on building homes on land that is classified as a rural area. Generally speaking, USDA Rural Housing Loans are primarily intended for individuals residing somewhere in the low- to middle-income bracket area who could use this assistance to cover the cost of construction.
Understanding SBA 504 Loans
The Small Business Association 504 Loan is targeted to small business owners who are purchasing land in order to facilitate the growth of their business. Depending upon your specific intent for the land you purchase, you may be able to take advantage of this powerful lending platform. According to current SBA 504 loan terms, qualified applicants will receive 40 percent of the land's purchase price from them.
A third-party lender is required to provide 50 percent of the remaining cost, while the borrower is responsible for the final 10 percent. Although borrowers are still required to contribute a portion of the overall cost, this is technically no different than the type of funds that would be required as part of a down payment on a conventional mortgage.
Home Equity Loans and Land Purchases
In the event that you have already paid a significant portion of your mortgage for your home, you may be able to use the built-up equity to help finance your land purchase. While some homeowners may jump at the chance to take advantage of a loan such as this, it is important to remember that a home equity loan offers your property as collateral in the event that you cannot repay your debt obligations.
With that in mind, it is entirely possible that you could lose your property to the bank if you cannot fulfill the terms of the equity loan. While this risk may not be a deterrent for some, it is important to assess your own risk tolerance in order to ensure that you are comfortable with these terms.
Seller Financing Opportunities
While a conventional land loan may technically be possible, many would-be borrowers will find themselves immensely frustrated by the lack of borrowing opportunities available to them. Land loan lenders, such as those mentioned previously, will provide financing for land purchases to borrowers, although the specific terms of this borrowing and the number of loans being offered will likely vary on an annual basis. Perhaps one of the most guaranteed forms of lending for land purchases is seller financing.
If you have decided to purchase land from an individual who already owns it, it could be in your best interest to negotiate financing terms directly with the seller rather than using a private lender or government program. If a seller is keen on handing over their property to an eligible buyer, the discussion can then begin as to what constitutes "ideal" financing eligibility for the would-be borrower.
Depending upon the level of excitement or desperation on the part of the seller, borrowers may be able to secure advantageous terms directly from the current owner of the property. However, it's also possible that seller-financed land comes with far less ideal borrowing terms than other government programs. Ultimately, it is up to the buyer and seller to discuss exactly how they envision the purchase and what should be done.
Moving Ahead With Your Loan
By and large, conventional land loans will be difficult to obtain for the vast majority of applicants. While alternative forms of land loan lenders may be plentiful, the conventional mortgage model simply does not match with land purchases. With that in mind, individuals who may be considering a land purchase may find that it is in their best interest to discuss their purchase with a lending specialist prior to committing to any specific arrangement.
Although the terms of a loan may be clearly dictated, individuals could benefit from reviewing this material alongside a real estate or lending professional. A loan for buying a lot is a huge investment, which is why it is worth the time to ensure that it goes as smoothly as possible.
Ryan Cockerham is a nationally recognized author specializing in all things business and finance. His work has served the business, nonprofit and political community. Ryan's work has been featured on PocketSense, Zacks Investment Research, SFGate Home Guides, Bloomberg, HuffPost and more.