Vacant land purchases – why they present a different challenge

Lending on vacant land presents both unique challenges and opportunities compared to traditional residential mortgages. Alexa DePaolo (pictured), senior mortgage loan officer at Edge Home Finance, told Mortgage Professional America how she evaluates and underwrites loans for vacant land purchases – and it’s not as easy as it sounds.

“The pre-approval process is almost identical,” she said. “We’re just comparing different loan terms. There are larger down payment requirements, and typically you’re seeing that the interest rates are higher.”

This often includes variable rates, with many land loans being adjustable-rate mortgages (ARMs) and some even featuring balloon payments.

“We need to be able to prep people accordingly for those balloons or for those variable rate increases on their interest rates,” DePaolo added. Upfront costs for land can be similar to, or lower than, those for a standard home purchase, but construction costs can increase substantially. Additionally, some clients might qualify for the land purchase but not the construction, necessitating careful discussions about long-term goals.

“What are their long-term goals? And although they can buy the land, can they also build on it later?” asked DePaolo. “Taking into consideration wells, and electricity, septic systems, and if those were already present on the land itself, because if they’re not those can be very costly.”

Due diligence is key

Speaking to MPA, DePaolo recounted instances where clients had to go off-grid or adopt alternative water systems due to unforeseen difficulties, underscoring the need for thorough due diligence. And, when asked whether her work mainly involves single parcels of land for individual homeowners or larger parcels for developers, DePaolo reveals they actually do both.

“My team and I focus on one parcel of land or multiple parcels of land multifamily,” she said. “We’ve had people looking at land and they wanted to build the home, and then potentially a commercial restaurant down the road. So we’ve had a lot of different options for people and I’ve addressed all of it.”

With a broad perspective across diverse real estate markets, DePaolo notes regional variations in borrower needs.

“When it comes to single-family homes, those vary widely. When it comes to land there really is not a huge variable,” she said.

Environmental factors, such as flood-prone areas, can also affect building plans, but the basic terms of land loans remain consistent.

“Colorado has the highest demand for land based on my experience over the last five years with land increasing land purchases increasing,” DePaolo added. 

Strategies for land loans

Whatever the challenge, DePaolo’s strategies and services are designed to guide clients through the complexities of land loans.

“Some common misconceptions are that land loans are identical to single-family homes, or condos just buying a standard primary secondary investment property home they are very different,” she explained. Key differences include higher down payment requirements, more restrictive debt-to-income ratios, and higher interest rates.

One innovative strategy she mentions is leveraging home equity to finance land purchases. “Sometimes it makes sense just to pull the cash out of a current home,” she added. This can provide clients with more flexibility and avoid the complications of variable rates or balloon payments.

Regarding construction loans, DePaolo’s approach is just as comprehensive and client-centric.

“We help people through the entire process, and we do one-time construction loans. We do construction loans and then refinances afterwards,” she revealed. This ensures that clients are prepared for all stages of their land and construction projects, from initial purchase to final inspection.

Considering economic and geopolitical factors, DePaolo has noticed a trend towards increased land purchases, driven by various motivations. DePaolo’s insights reveal a growing interest in affordable, smaller homes, and land that offers a peaceful retreat. This trend is reflective of broader societal shifts towards simplicity and self-sufficiency.

“We live in such a fast-paced life,” she told MPA. “I think a lot of people are really enjoying being a bit farther away from the city and wanting to fish and camp and have just a go-to area for that. That’s what a lot of my clients have expressed. It’s either come from a place of not knowing what’s going on in the world or being so overwhelmed with life they want a place where they can check out and start that process with their family.

“And so I’d say the biggest changes that I have seen is people really wanting to get into more affordable, smaller homes that are a bit more peaceful, further away from town.”