Understanding Land Lot Loans for Rural Residences
One would think that in this topsy-turvy economy with the Coronavirus and the volatile political landscape that the demand for rural homesite lot property would be marginal at best. That isn’t the case. As a rural real estate professional, I speak to sellers and buyers nearly every day and we are seeing a significant uptick in interest for rural property. This means I get a lot of questions about how to get a loan to buy a lot, land lot loan rates, and lot loan financing.
We are finding that people who may have previously kicked around the concept of relocating out of the city to their own 10 acres or more country retreat are now starting to make that self-sustaining lifestyle a reality.
We’ve found that many prospects don’t realize that financing a rural home parcel isn’t the same as funding a home with a conventional mortgage. To help shed light on the differences and considerations, we caught up with Travis Jordan from Alabama Ag Credit, a financial coop with nine locations in Alabama to help us understand land lot loans for rural residences. That interview can be heard below.
“Rural home sites have always been a big part of our business but I can’t remember a summer where we’ve been as busy as we have been this year,” Jordan said.
If a potential land purchasers is pondering how to get a loan to buy a lot, Jordan explained that there are a number of things they need to keep in mind when it comes to rural land and homesites and evaluating lenders.
From Alabama Ag Credit’s perspective, the size of the property isn’t of great importance as long as it is outside the city limits and the population size is less than 2,500 people. In addition, AAC offers borrowers 85% “loan to value”, which means that they can provide up to 85% of the purchase price or the appraised value, which is higher than many other lenders. Also, since AAC has their own appraisal “shop”, their appraisal cost is less.
“Most institutions that offer lot loan financing are going to be somewhere between 65 and 75% of the purchase price or appraisal and that is a huge factor in terms of money down,” Jordan said. “Also, since we have our own appraisers, the cost for an appraisal is only $200 which is inexpensive.”
With an eye towards helping borrowers save money, Jordan encourages them to seriously consider a shorter amortization term for their home site. A borrower may favor a 30-year term since the required monthly payment will be less. On the other hand, a 15-year product allows them to build up more equity by paying down the principal faster. Depending on the time lapse between when the property is purchased and a home is built means that the raw property can appreciate in value.
“Going with a shorter amortization term for financing a piece of property means that when the time comes to build that house, they will need less money down to pay for the construction loan,” Jordan pointed out. “A construction loan will need a new appraisal and any appreciation will be assessed and go towards the equity needed to construct the loan.”
“Both of these things are going to help soften the burden of the down payments required,” he added.
Jordan points out that while a 30-year mortgage will have a slightly smaller monthly payment, the 15-year mortgage goes so much further in reducing debt and is almost like a forced savings account that can help fund the down payment of a home construction loan if that is the goal.
“Borrowers really light up when they find the payment difference for a 15 and a 30-year loan isn’t significant and then again when they see the difference on the principal balance after five years on 15 verses a 30-year mortgage,” Jordan shared. “When it is broken down that way, they understand how their money is working harder for them with a 15-year mortgage.”
Jordan explained that when it comes to “improvements and assets” it is a case by case situation and each can take on a different twist.
For example, if an owner builds a pole barn, constructs a fence in the property or makes other improvements and is “prepping” the property prior to building, the improvements may or may not factor into the appraisal. That includes wooded parcels.
“If you bought five acres and cut the timber to get it ready to build your house, we’re not much interested in that,” Jordan said. “If it was 200 acres, we’d want to be on the front end with discussions because that may require some principal reduction depending on where you are in your loan and collateral.”
Speaking of collateral, one of the things that Alabama Ag Credit offers that many other lenders don’t is the ability to leverage other property and assets by “pledging” them to go towards the down payment. That flexibility provides more options for the buyer in assembling that down money and allows them to finance less on their land lot loan.
While the concept of just buying some land out in the country and building a home is pretty simple, depending on what someone wants, lot loan financing can become complicated.
“For instance, you can’t go to any traditional bank and get a construction loan on what we call a ‘barndominium”, which is a barn or metal building that includes living quarters and storage,” Jordan said. “AAC is one of the few financial institutions that cater to people looking to build homes that are not of the cooker cutter type that you would find in your traditional neighborhood.”
Alabama Ag Credit offers a sheath of smaller services and procedures that, on the surface, don’t seem very significant but in essence, all contribute to the quality of the land lot loan package.
A case in point are comparables. In a normal real estate transition, agents and institutions analyze the market to find what comparable properties are selling for. The problem arises when you have a non-traditional property, like a barndominium, that sits on 30 acres and it isn’t easy to find something similar to support the cost of the construction.
“Our appraiser might have to go to the next town or even the next county to find a barndominium that sits on similar acreage but we aren’t restricted in the same way that other financial institutions may be,” Jordan said. “We also have the ability to work with just about any builder who is licensed in the state and in good standing.”
What about financial instruments and land lot loan rates?
According to Jordan, for lot loan financing, rates are historically well even with the uncertainty of the Covid and the roller coaster economy.
“Right now, the interest rate on a 15-year land loan is around 3.75%, depending on the type of mortgage you get,”
Jordan said, “If you go to a traditional bank and get an adjustable rate mortgage product, your rate will only be fixed for five to seven years and then you have to get a new loan.”
“I tell people who have the intention of building within a five-year period that the cost of a five-year rate and a fixed rate for the whole 15 years isn’t that different and to go ahead and lock it in,” Jordan adds. “On a 20 year, land lot loan rates are in the low 4 to 4 ¼ range and it is a really great time to take advantage of a lower rate environment and a flat yield curve across the whole spectrum.”
Jordan points out that one of the best and profitable benefits of working with Alabama Ag Credit is the fact that since it is a “borrower owned” institution, every year that it shows a profit it returns some of that money to its members in the form of a “patronage” check.
“For the last 15 years consecutively, we’ve paid a patronage. For the last 8-10 years it has averaged close to 1%,” Jordan said. “On a $100,000 loan at 1% that is $1,000,”
“The way I look at it is if my land lot loan rate on my home site is set at 3.75% and Alabama Ag Credit pays me 1%, effective that year, my interest cost was 2.75% and that is pretty cheap money,” Jordan concluded.