What is a land loan? How to buy vacant land

ALASDAIR DUNCAN
What are land loans, how do they work, and what are some things you should consider if you have your eye on a vacant block?

Say you’ve found a block of land in an area that you love. You have big plans to build a house there in years to come, perhaps a new home for your family or the retirement home you’ve always dreamed of, but you’re not ready to get things started just yet. If this is the case, or even if you just wish to purchase land as an investment to sell down the line, then a land loan might be an option for you. In this article, we’ll answer some questions you may have in this area, including:

What is a land loan?

A land loan is a type of home loan that you can take out from a bank or other lender to purchase vacant land. Typically, this is done in order to build a house on the land in future, either as a home for you or as an investment property. It can also be the case that a buyer wishes to hold on to the land as an investment, to sell in future if the value increases. With a land loan, the block of land is used as security for the loan.

Lenders can take a more conservative approach to land loans than other types of home loans, as they are perceived as being riskier. This is due in part to the potential for land prices to fluctuate, and the perception that land can take longer to sell.

For this reason, land loans can have stricter lending conditions attached, such as requirements for larger deposits and higher interest rates in some cases.

How do land loans work?

In a general sense, land loans are similar to other types of home loans. When you apply for one, a lender will assess your borrowing power, which is the amount of money they might be willing to lend you, by making inquiries about your income, assets and any debts you may have.

In addition to these inquiries, when you apply for a land loan, the lender will also take into consideration the block itself. For example, the lender may factor in the size and location of the land, how easily accessible it is, the availability of infrastructure like roads and utilities, and what you intend to do with the land.

If you have a plan to build an owner occupied home, for instance, then a lender may consider your application to be less risky than if you plan to build an investment property on it, or have no concrete plans at all for what you wish to do with it.

What kind of deposit do you need for a land loan?

The deposit required for a land loan will vary based on the cost of the block you wish to purchase and your lender. It is worth keeping in mind that land loans can sometimes have a lower loan to value ratio (LVR) requirement than other types of home loans, which means that the deposit you’re required to pay may be higher.

LVR describes the maximum proportion of a loan that a lender is willing to offer you. For example, a lender may approve your loan for 80% of the land’s value, which means you will be required to pay the remaining 20% as your deposit.

Because lenders tend to be conservative when approving land loans, the LVR may be lower than 80%, which would in turn require you to pay a larger deposit, but the exact LVR would be a matter of negotiation between you and your lender.

Are you required to build if you take out a land loan?

One of the advantages of taking out a land loan is that there is often no requirement to begin construction on a house immediately. This makes them different from construction loans, which are loans that are designed to finance the building of a house on a vacant block of land, or a major renovation project. Bear in mind, though, that some lenders may still require you to build a property on the land within a specific period.

Another key difference between the two types of loans is that with a land loan, all the funds are released straight away, whereas with a construction loan, they are released at intervals throughout the build, when major milestones are complete. This means that with a construction loan, you will only pay interest on the amount of money you have drawn.

If you have your eye on a block of land and plan to start building soon, then a construction loan may be appropriate for your needs, keeping in mind that these kinds of loans typically come with a deadline of 2-3 years to finish the build. If you have no immediate plans to build and anticipate that the land will remain vacant for a while, then a land loan may be more suitable in the short to medium term. If and when you do decide to break ground on a new house later down the line, a construction loan might then be an option to fund this.

What should you look for in a land loan?

When comparing land loans, it is important to keep in mind such considerations as the interest rate attached, any fees and charges that may apply, the size of the deposit required, and your own plans and intentions for the land itself.

Interest rates

Because lenders view land loans as riskier than other types of home loans, the interest rates attached to them can be higher, which means you can end up paying more over the lifetime of the loan. When comparing loans, it is therefore worthwhile to consider which lenders may be able to offer you the lowest interest rates.

Fees and charges

Similarly, given the risk that lenders attach to land loans, some may charge higher fees, so this is another factor to keep in consideration when comparing. The comparison rate is an estimate of the total cost of a loan over a year, taking in fees and charges as well as interest, and lenders are obliged to disclose this to you along with the interest rate of a loan.

Deposit

The lower the LVR of a loan, the higher the deposit you will be required to pay. If a lender offers you a high LVR for a land loan, it may mean you are required to pay less of a deposit, but it is important to keep the comparison rate of the loan in mind, and consider how much you will pay in total with interest, fees and charges factored in.

Your future plans

Your intention for the land is also an important factor. If you are able to approach a lender with a clear plan for what you intend to do with the land you hope to purchase, then they may be more willing to loan you money on terms that you find favourable.