Should I buy a lot and build a home?

Are you simply not finding the home of your dreams among houses currently on the market? You may want to buy a lot and build your own. Buying land and building a new house has a few extra considerations, so here’s what you need to know.

Buying Land or a Lot

It can be harder to get a loan for buying undeveloped land or a lot than to get a mortgage, especially if you aren’t building immediately. These types of loans usually require a higher down payment and have a shorter term, since the lenders will consider them higher risk.

Construction loans

It’s easier to get a loan for land or a lot if you plan to build immediately. This allows you to get a construction loan. There are two main types of construction loans:

Short-Term

With a standard short-term construction loan, you get an initial loan to cover costs of buying your land and pay for construction, but as soon as construction is finished you must apply for a new loan. The new loan is a traditional mortgage and it pays off the construction loan. A disadvantage of pure construction loan is that interest rates are typically high, and you’ll have to pay closing costs both for the construction loan as well as the mortgage needed to refinance the construction loan. This opens up the risk of qualifying for a traditional mortgage when your home construction is complete. What if you lose your job or decide to start your own business? These are both big issues when applying for a mortgage. The other risk is what if rates go up between the start and completion of construction. Interest rate risk works both ways but it could lead to a big surprise if rates spike.

All-In-One

An all-in-one loan or construction to permanent resolves the issues with a true construction loan by making the transition from construction phase to regular home mortgage seamless. Instead of having to undergo a refinance process that includes requalifying for your mortgage, there is a simple conversion process that allows you to shift from the construction loan into your mortgage setup without going through approval and closing again. The benefit to this is you only pay closing costs once and you eliminate the risk of rates moving higher during your build. The downside to these programs is you’ll generally pay above market rates and closing costs.

Pros and Cons of Buying Land and Building

There are several potential benefits to buying land or a lot and then building a custom home.

• First, you’ll get to design exactly what you want, creating the home of your dreams from the ground up.
• Second, you have the chance to get in early in new neighborhoods (leading to a high potential for fast equity if the property rises in value.)
• Third, you may be able to buy land very inexpensively depending on the area, and reduce your total costs of home ownership.

There are also some disadvantages to this plan.

• Getting loans for this type of plan can be more difficult, as the application process can be more rigorous.
• Many specialty loan programs designed to provide for a lower down payment won’t be accessible.
• If the property value drops, you could end up with an “underwater” loan by the time your house actually gets built.
• The process can be extremely time consuming and stressful and issues always arise during construction.
• Costs can balloon out of control. Unexpected issues can cause costs to jump and the cost of materials can skyrocket. If you’re ever curious as to how volatile construction costs can be just look up the cost of lumber between 2018 and 2021.
• Labor costs can fluctuate as well and can cause delays. Lack of available workers has been a huge issue over the past few years.

Think carefully about your decision, and consider finding a real estate agent that specializes in land purchases to help you if you decide to buy a lot or piece of land. Then choose a mortgage company that can help you get preapproved for the right kind of loan to make your dreams come true.

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