Can you use land for the down payment on a construction loan? We bought a plot of land with cash and want to know if it can be used as a down payment when we apply for a construction loan to build a home.
The down payment required for a construction or construction-to-permanent (C2P) loan varies but is usually 20% to 25%. The good news is that the value of the land can be used for all or part of the down payment.
For example, if you buy a plot of land for $20,000 in cash and want to construct a home with a total building cost of $80,000, you need a construction loan for $80,000. If the lender requires a 25% down payment, that means you need to put down $20,000. In this case, you can use the value of your land instead of your personal funds to meet the down payment requirement.
If the value of the land is higher than the down payment required, you may be eligible for a higher construction loan amount. If the value of the land is lower, you likely need to contribute your own funds to qualify for the loan. Returning to the example above, if the land is valued at only $15,000, you need to personally contribute $5,000, to meet the required $20,000 down payment.
We recommend that you contact multiple lenders in the table below to learn about construction and C2P loan terms and qualification requirements. Shopping lenders enables you to find the lender and program that best meet your needs.
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Please note that lenders use the net value of the land to determine its contribution toward your down payment for a construction loan. This means lenders subtract any liens or mortgages secured by the property from the land's value. For example, if you own land valued at $50,000 that has a $20,000 mortgage, the net value of the land is $30,000, which is the figure the lender uses for your down payment.
Using the net value of the land is a non-issue if you own the property free and clear but if a property has significant debt then it may not help you satisfy the lender's down payment guideline.
Additionally, depending on when you purchased the land, the condition of the property and other factors, you may be required to obtain an appraisal to determine the value of the land. If you acquired the property several years ago, the value may have changed and lenders want to use the current property value when you apply for the mortgage.
The only time you run into an issue when you use land as the down payment on a construction loan is if the value of the land is low relative to the construction cost to build the home. In this scenario, your loan-to-value (LTV) ratio, or the ratio of your mortgage relative to the fair market value of the property, may exceed the lender's limit, which is usually 75% to 80%.
For example, let's say you purchase a plot of land for $10,000 cash and want a $100,000 construction or C2P loan to build a home. Even if the lender only requires a 20% down payment, or $20,000, this is significantly higher than the value of the land. In this scenario the lender usually requires that you contribute more funds to meet the down payment requirement. Your other alternative is to apply for a smaller construction loan.
In short, while land value can provide the down payment for a construction or C2P loan, the answer to your question depends on your specific situation including the value of the land, the cost of construction, loan amount and other factors.
One other point we should highlight is that we recommend that you obtain a C2P loan rather than a straight construction loan. A construction loan is a short term mortgage that is replaced with a new, permanent mortgage after the home is built and you are ready to move in.
A C2P mortgage is a single loan that includes both the short-term construction loan as well as the permanent take-out loan that is put in place when the building is complete. By using a single mortgage program for both the construction and take-out loans, a C2P loan can save you time and money. You may also be able to qualify for a higher mortgage amount with a C2P loan as compared to a construction loan.
Review How Construction-to-Permanent (C2P) Loans Work
Finally, you can use the FREEandCLEAR Lender Directory to search over 3,900 lenders by loan program. For example, you can find top-rated lenders in your state that offer C2P and construction loans.
Sources
"Construction-to-Permanent Financing: Single-Closing Transactions." Mortgage Products. Fannie Mae, August 2019. Web.
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