Reprinted from Rethink Rural
We talk to the experts to weigh the pros and cons of 8 ways to buy land, including cash, owner financing, buying with a partner, land loans through banks and credit institutions and more.
One of the most common questions about purchasing raw land is how to pay for it.
There are numerous options to explore, including paying in cash, taking out a loan or even buying through seller financing.
But what are the pros, cons and risks associated with each land financing method? We turned to three experts to find out. Below, we share tips from:
- John Weidenhaft who was a land broker for more than 20 years before coming to work for Rethink:Rural’s parent company, Raydient Places + Properties, in Fernandina Beach, Florida.
- Landon Reneau, a senior loan officer at Capital Farm Credit in Conroe, Texas.
- Russ Walters, an Andalusia, Alabama-based real estate agent with Southeastern Land Group who formerly worked in the banking industry.
Below, we outline the pros and cons of eight land financing methods:
1) Buying Land in Cash
A cash buyer has all of the funds to purchase a property at the time of sale without the need to borrow money.
PROS OF BUYING IN CASH:
- Strong negotiating power: Using cash assets to purchase rural land can put the buyer in a strong negotiating position: since the hassle and paperwork associated with other buying methods won’t apply, a cash sale is easier to manage and the final payout for the seller is easier to predict.
- Lower overall cost: Since a cash buyer is so much more attractive to the seller, there may be more flexibility on price. In addition, a cash buyer will deal with less fees, such as application fees, closing fees and bank appraisals. (However, a title search and survey will still be needed on the property.)
- Quick turnaround: Cash buyers also have the advantage of time. If they need to make a quick decision to get in on a good deal, they’re able to act fast because they have the funds on hand and don’t have to wait for a bank to approve loan financing or for an appraiser to complete an appraisal. (However, Weidenhaft cautions, it is prudent to get an appraisal unless you’re well-versed in researching property values).
- Less risk: By purchasing in cash, a buyer leaves the transaction without owing anyone money, avoiding risks associated with some other forms of financing that could lead to court hearings if both parties do not adhere to the agreed-upon terms and payment schedules.
CONS OF BUYING IN CASH:
- Loss of liquid funds on hand: “The only real downside is using your available cash,” Weidenhaft says. “Do you want to deplete your cash reserves to buy the property?”
Walters says he only recommends cash purchases to “people that are financially stable enough to withstand market corrections and economic downturns.” He says he has seen buyers use their cash for a land purchase and then lack the funds needed to buy a tractor, build a barn, or install power and water.
“The buyer is better off to finance his purchase and use his personal funds for these expenses. Sure, you can borrow funds for these items but it is a much more burdensome process,” he says. By reducing liquidity, the buyer won’t have the cash available for a quick purchase in a different industry that may require more speed, adds Reneau (real estate closings are usually 30-60 days after a contract is agreed upon).
- Limits what you can buy: Depending on how much cash the buyer has, relying on readily available funds may greatly limit what that person can purchase.
2) Buying Land with Owner Financing
A buyer who purchases land through owner financing essentially uses the seller as a “bank,” making payments over time to cover the cost of the property. If the buyer fails to pay, the seller can foreclose on the property.
PROS OF BUYING LAND WITH OWNER FINANCING:
- Poor credit is not a problem: Buyers who are most attracted to this form of payment have poor credit, thus receiving a traditional loan may be difficult if not impossible.
“The buyer can get into a land purchase with a lot less money upfront,” explains Weidenhaft. “In most cases, if you’ve got the down payment, you qualify.”
- Down payments are typically lower than banks would require: Reneau says they’re usually between 5 and 10%.
- For the seller, it ensures regular payments: Assuming the buyer makes reliable payments, the seller can count on a steady income over the life of the financing, which is attractive to some sellers.
- For the seller, there can be a higher return: “Generally speaking, the interest rate the buyer will be paying is much higher than what the seller would earn with another investment, such as a CD [or, Certificate of Deposit],” Weidenhaft says.
CONS OF BUYING LAND WITH OWNER FINANCING:
- Higher interest rates: In exchange for taking on the risk of owner financing, sellers charge higher interest rates, ultimately collecting more on the property than they would have with alternate forms of payment.
“We’ve seen, in the end, it’s usually a lot more costly than if the buyers had saved the money or gotten their credit scores up instead,” Reneau says.
- Financing documents may place buyer at risk: Since a seller is not regulated by agencies the way a bank or farm credit is, the terms of the financing may create more risk for the buyer.
“Be very wary,” warns Walters. “Always have your own attorney review the owner financing documents before signing off.”
- Risk of inaccurate accounting: The seller is the “accountant” for this type of financing, so the onus is on that individual to keep track of payments, interest rates, the loan schedule, and the terms that were agreed to.
“There are some major potential drawbacks,” warns Reneau. “You’re relying on that owner to maintain a good accounting system. For example, if you get a bonus and pay in advance, does the owner know how to handle that? We see a lot of cases in which the owner financed and there were discrepancies on the balance and payment schedule.”
Owner Financing Tip: “At the end of each year, it is always a good idea for the buyer to request a statement from the seller reflecting the total payments received for the year, the amount that was interest, the principal payment amounts and the remaining balance,” Weidenhaft says. “The buyer can then reconcile that with his records. It is much easier to find and correct an error that occurred in the previous year than trying to find one that happened five to ten years ago. These statements may be critical if the seller’s records are inadequate or if the seller becomes incapacitated or dies.”
- Different set of rules for foreclosure: While banks have a set schedule and warning process to follow before foreclosing on a property due to late or missed payments, individual sellers don’t have to follow the same regulations. Each state has its own guidelines for the process.
Reneau says in Texas, if a buyer is more than 15 days late on a payment, the seller can immediately start the foreclosure process – even without first notifying the buyer.
- Complications when taking ownership of the property: Once all payments are fulfilled, if the seller doesn’t come through, the buyer may have to go to court to force the seller to honor the contract, taking on additional fees to bring the case before a judge. If something happens to the owner before payments are completed, whoever is responsible for the owner’s estate may not be apprised of the agreement.
“If the owner dies, you have to rely on the heirs to agree to the terms. You could easily end up in court,” Reneau says.
Florida statues give the seller a specific time frame within which he must provide the buyer with a recorded satisfaction of mortgage after the final payment has been made.
THERE ARE CONS FOR THE SELLER WHEN A BUYER USES OWNER FINANCING, TOO:
- The seller isn’t getting all of the funds upfront, but rather has to wait to receive the cash over an extended period of time.
- If the buyer stops making payments, the seller may have to activate the foreclosure process, which can be costly.
“The filing fee for foreclosure is expensive — $3,000 or better in most places,” Weidenhaft says. “If a buyer pays $1,000 down and just a few regular payments, and I have to foreclose, I’m in a hole in a hurry.”
In addition, until the foreclosure process is complete, the owner most likely will not receive any money on the property.
“The seller is assuming the risks that a bank normally would,” explains Walters. “They’re leaving themselves open to downturns in the market when a property could potentially lose value and the buyer walks away from the property often with the property in an undesirable condition.
3) Buying Land Through a Lease with an Option to Purchase
When a buyer leases property with an option to purchase, the lease is established for a set period of time. Terms vary depending on the specific contract the buyer and seller agree to: The money the buyer pays for the lease can be applied to the land purchase in part or in whole, and can be used as principal funds or interest funds. If funds from the lease do not fully cover the purchase, the buyer may convert to owner financing for the remainder of the purchase price.
PROS OF LEASING LAND WITH AN OPTION TO PURCHASE:
- Flexibility for buyers still unsure about the land: Buyers prefer a lease with an option to purchase when they’re not entirely sure they want the property. They have the choice to walk away.
“Unless they’ve done something to devalue the property, they don’t owe a dime,” Weidenhaft says.
- Lower upfront costs: “Sellers generally take a lower downpayment than they do with owner financing,” Weidenhaft says.
- Helps build equity: Using a lease with an option to buy property also can help the buyer build equity in the property more quickly than some other purchasing methods, since the buyer is making routine payments.
CONS OF LEASING LAND WITH AN OPTION TO PURCHASE:
- Higher overall cost: Just as with owner financing, a buyer who uses a lease with an option to purchase ultimately pays a lot more for a property than a cash buyer.
- No guarantees about the land: The buyer faces risks associated with the land, itself.
“Unless they get a survey and title insurance, there may be problems with the property they aren’t aware of,” Weidenhaft says.
- Risk of going to court: The buyer faces risk associated with how reliable the seller is. While they have a contract stating they will, for example, convert to owner financing after a certain period of time passes, the buyer will have to take on court costs to enforce the contract if the seller doesn’t comply.
- For the seller, there is also risk: If the buyer doesn’t make payments, the seller may have to take on the cost to have the buyer evicted.
4) Buying Land with a Partner
Two or more people can join together to share in the cost and/or responsibilities of purchasing a property, taking on the benefits and the risks together.
PROS OF BUYING LAND WITH A PARTNER:
- Shared costs: By sharing costs for a land purchase, partners can get into a property with less money, and they can buy a larger piece of property together than they could on their own.
- Shared responsibilities: One partner may purchase the property while the other takes on the day-to-day maintenance of the land, enabling each to do the part they’re capable of doing while the other partner takes on the aspect they weren’t capable of.
- Shared risks: Someone else is investing with you, thus you both have a share of the risks associated with the purchase rather than one person taking on all of the risk.
CONS OF BUYING LAND WITH A PARTNER:
- You share decision-making. Even when partners know and trust each other, there are a lot of factors they have to agree on: what to spend money on, when to sell, insurance, taxes, and so on. Each partner must meet deadlines to make payments, and if one defaults, it can lead to a sticky situation.
“Being partners with someone is like getting married. I’ve been in partnerships that have worked out extremely well, and partnerships that didn’t work out well at all,” says Weidenhaft.
- Unequal financing can result in disagreements about the investment timeframe: Walters explains: “A wise investor once told me, ‘Always be equally yoked with your partner.’ What this means is, partner with someone who has similar finances to yourself. You don’t want a poor partner for all of the obvious reasons. A very rich partner can often weather the storm longer than you can and can be very resistant to sell or change when you are experiencing difficulty. Additionally, the richer investor will usually always want to hold out for better gains down the road. Both parties need to have the same investment timeframe.
5) Pros and Cons of Buying Land with a Traditional Bank Loan
While many traditional banks shy away from land loans due to inexperience with land, some will offer loans for land purchases.
PROS OF BUYING LAND WITH A TRADITIONAL BANK:
- Simplicity of working with your bank for all your needs: If you already have a relationship with a bank and have other financial matters connected to that institution, it can be convenient to continue working with them. You have the peace of mind of working with a bank you trust and, as a trusted customer, they may be more willing to work with you than an unknown buyer.
- Protection for the buyer: A traditional bank is highly regulated by the federal reserve, explains Reneau. “The consumer has someone on their side from a regulatory standpoint.”
- More options: Banks may be able to offer different types of financing depending on the length of time the buyer needs to repay the debt. The longer the term, the higher the interest rate typically will be.
Bank Loan Tip: “Commercial banks usually have more flexible terms than regional banks and other institutions,” Walters says. “They can sometimes do loans with as little as 10 percent down payment and can loan money for improvements to the property. Commercial banks also usually have less rigid credit requirements.”
CONS OF BUYING LAND WITH A TRADITIONAL BANK:
- Banks are less familiar with land: Since traditional banks do not typically work with land purchases, they will have a more difficult time dealing with any out-of-the-ordinary issues that could arise with the property purchase.
- Higher, more variable interest rates: Banks typically charge a higher interest rate for land purchases than they do for home purchases (because the risk is considered higher without a home they can possess if they buyer defaults on payments).
The interest rates also typically exceed those of farm credit institutions.
“Commercial banks’ interest rates have become more competitive in recent years on land, but they usually lag the interest rates offered by the farm credit institutions,” Walters says. “They do not offer the long term rates that can be found at a farm credit institution. This can leave the buyer susceptible to future increases in interest rates, which can make it harder to repay a loan.”
- Closing process more costly and lengthy: The buyer usually has more closing costs with traditional banks, and these purchases also take longer to close.
Weidenhaft strongly recommends “shopping around” before you choose your lender. “Even paying $100 extra per-month, you’ll end up paying $36,000 extra on a 30-year loan.”
- Less flexibility: While smaller banks may have some leniency in how they set up the terms of a raw land loan, larger banks have set standards in what they can and cannot do.
6) Buying Land with a Farm Credit Institution Loan
Farm credit institutions were set up by the U.S. government specifically to aid in the purchase of land. These institutions specialize in large acreage purchases and understand the nuances of the land-buying process, as explained here in our interview with Farm Credit of Florida’s senior loan officer.
PROS OF BUYING LAND WITH A FARM CREDIT INSTITUTION:
- Familiar with land sales: Since land is farm credit institutions’ specialty, it would be rare to run into a circumstance they haven’t dealt with before, making even a complicated land purchase run smoothly.
“They’re the first people I’d talk to if I was buying land,” Weidenhaft says.
- Lower upfront fees: Farm credit institutions have internal staff — such as in-house appraisers — that could help cut a buyer’s upfront costs. In some cases, they are also able to offer a lower down payment requirement.
- Country-friendly fee schedules: Once the property is purchased, farm credit institutions are able to offer payment processes that are more compatible with country lifestyles. For example, they can adjust payment schedules to ensure money is due after a farmer has taken his cows to market each year.
- Member rewards: As part of receiving a loan from a farm credit institutions, buyers become members of their institution, meaning they may receive rebates or other payouts as part of their membership.
- Buyer Protection: The federal farm credit system protects the buyer at a higher level than many other financing options. For example, if a buyer fails to make payments, the institution will try to help.
“We have to offer you a distressed loan restructuring if you have trouble making your payments,” says Reneau. “We’ll try our best to work the deal out.”
- Competitive rates: Farm credit institutions normally finance with 20-25 percent down and have rates that are competitive with traditional banks.
“Farm credit institutions can normally do up to 30-year amortizations with their loans and they have the ability to lock interest rates for up to 15-20 years on land loans,” Walters says. “This is a tool to which they have a tremendous advantage over other lenders. Most commercial banks only offer a 5-year balloon note.”
CONS OF BUYING LAND WITH A FARM CREDIT INSTITUTION:
- Harder to qualify for a loan: It may be difficult for a buyer with poor credit to get a land loan through a farm credit institution.
- You must meet gross monthly income requirements: The buyer has to have an income that suits the institution’s gross monthly income ratio requirements (the buyer’s purchase price can be no larger than a certain percentage of the buyer’s overall income). (All financial institutions have some level of income requirements.)
- Not the cheapest way to buy land: While using a farm credit institution is more cost-effective than owner financing or leasing to buy, it is more costly than purchasing in cash.
- High down payment: Farm credit institutions typically seek at least 20 percent down payment for a land purchase. It can be difficult for some buyers to come up with those funds upfront. Although, on the bright side, it’s that much less money you’ll have to pay off on the loan.
7) Buying Land with a Land and Home Package
Some institutions and sellers will offer a package deal to buyers at a lower rate. By purchasing the land and the home that will go on it at one time, the combined loan can be more affordable. Sometimes these packages are offered by banks, and other times they’re offered through a home builder or manufactured home company.
PROS OF BUYING A LAND AND HOME PACKAGE:
- Convenient: The biggest pro to these packages is convenience, from having everything packaged into one bill to the logistics of transforming the property into a homestead.
- The home company arranges details: When you purchase a land and home package, the home company usually takes care of the details, such as getting building permits and installing a well and septic system.
- Benefits of using tried and true contractors: These companies regularly work with contractors, so they know who to call and can often move through the process much more quickly than a buyer doing it all for the first time.
- Less money required upfront: Using this route can result in a much lower down payment requirement. These packages often have a lower fixed interest rate too.
CONS OF BUYING A LAND AND HOME PACKAGE:
- Fees may have to be paid first: Depending on how the specific land and home package is set up, many companies require that fees are paid in full before work begins, which can create significant delays.
- Not always a money-saver: While the package is convenient, sometimes it is not significantly different in price.
- Heavy limitations: Land and Home packages are often geared toward a specific property and home size. Reneau and Walters both report the packages they are familiar with won’t work for a property larger than 10 acres.
“I usually recommend separate loans for home and land deals,” Walters says. “I advise my clients to use the commercial banks for the home part of the loan and farm credit institutions for the land part.
“Once construction is over, the buyer can finance the home into a 30-year fixed rate mortgage through a mortgage company.”
“Commercial banks are usually more flexible during the construction of the home and have better lending tools for homes,” says Walters. “They also will allow the buyer to subcontract some of the services. Farm Credit institutions normally require lock and key contracts where one contractor will be over the entire process.”
8) Buying Land through a Loan from a Relative or Friend
Some land buyers have a friend or relative who can lend them the cash to purchase land outright.
PROS OF BUYING LAND WITH A LOAN FROM A FRIEND OR FAMILY MEMBER:
- Strong negotiating power, lower overall cost, quick turnaround: A land buyer who uses cash from a friend or relative to purchase property enjoys all the same benefits of a cash buyer (detailed above).
- Low interest rate, if any: Often, relatives or friends agree to have the buyer pay them back with little – if any – interest.
CONS OF BUYING LAND WITH A LOAN FROM A FRIEND OR FAMILY MEMBER:
- Hard to find a willing “lender” for this large of a purchase: The most obvious con is the difficulty of finding a friend or relative with the means and willingness to supply the cash for a land purchase.
- The “What If?” Factor: You could find yourself in a bind if the same person who lends you money later falls into financial trouble, themselves.
“You’re not legally obligated, but you may feel emotionally obligated,” Weidenhaft says. He recommends having a written agreement to ensure the terms are understood by both parties upfront.
While there is no “perfect” way to purchase land, arming yourself with information about the pros and cons associated with each method will help you avoid risk and get the best value for your dollar. Don’t be afraid to contact a number of institutions and shop for the best terms for your money.