Does a Construction Loan Include the Land?

When building a new home, a common question arises regarding how the land fits into the financing picture. Construction loans are designed to fund the creation of a new property, but whether they include the land purchase depends on the specific loan type and the borrower’s existing situation. Understanding these distinctions is important for anyone considering building their own home.

Construction Loans That Incorporate Land Purchase

Some construction loans are structured to finance both the acquisition of the land and the costs associated with building a home on it. This integrated approach, often referred to as a “construction-to-permanent” or “one-time close” loan, streamlines the financing process. A single loan covers the land purchase and all construction expenses, then automatically converts into a permanent mortgage once the home is completed.

This type of loan offers benefits such as a single closing, which can reduce paperwork and overall closing costs compared to obtaining separate loans for land and construction. The land’s value is factored into the total loan amount. During construction, borrowers typically make interest-only payments on disbursed funds.

Government-backed options like FHA and VA one-time close loans also exist, allowing for the land purchase to be included. FHA one-time close loans may require a minimum 3.5% down payment. USDA one-time close construction loans can combine financing for lot purchase, construction, and permanent mortgage into one loan, often with no down payment.

Construction Loans for Land You Already Own

For individuals who already own the land where they plan to build, construction loans typically focus on building costs only. This often involves a “construction-only” loan, providing funds exclusively for the construction phase, assuming clear title to the land. The land itself serves as equity or collateral for the loan.

Land ownership can arise from various situations, such as inheriting property, purchasing with cash, or financing separately through a land loan. The value of owned land can satisfy some or all down payment requirements for the construction loan. Lenders view pre-owned land positively, potentially leading to more favorable terms as it demonstrates borrower investment and reduces lender risk.

When the land is already owned, funds are disbursed in stages, known as draws, as construction milestones are met. After construction is complete, the borrower typically secures a separate, permanent mortgage to pay off the short-term construction loan. However, some lenders may offer a construction-to-permanent option, integrating the land’s equity into a single loan structure.

Key Considerations for Financing Both Land and Construction

Regardless of whether the land is included in the construction loan or owned separately, several financial considerations are important. An “as-completed” appraisal is a standard requirement, which estimates the property’s value once construction is finished. This appraisal considers building plans, specifications, and budget to determine the future value of the home and land. Loan amounts are often based on a percentage of this appraised “as-completed” value.

Equity and down payment requirements are significant. Lenders typically seek a down payment ranging from 10% to 25% of the total project cost for construction loans. If the land is already owned, its unencumbered value can contribute towards this equity, potentially reducing the cash down payment needed. The loan-to-value (LTV) ratio, comparing the loan amount to the property’s value, is a factor lenders use to assess risk, with lower LTVs often resulting in more favorable terms.

A borrower’s creditworthiness is a primary factor in securing construction financing. Lenders look for a strong credit score; conventional loans often require 680 or higher, though FHA loans may accept scores as low as 580 with specific down payment requirements. A low debt-to-income ratio and stable income are also important financial indicators lenders consider to ensure loan repayment.