Refinancing Land Loan – Key Factors to Consider

If you want to build a home or commercial property, you can take a land loan to finance your quests. The land loan is used solely to purchase a tract of land. It doesn’t cover the cost of constructing a property (you’ll need a construction loan for that). The land loan is ideal for people who want to lock down a block of land but aren’t planning to start building their dream home within the next 12 months.

Refinancing your land loan allows you to take advantage of decreasing interest rates or switch lenders.

What Does Land Loan Refinancing Mean?

Land loan refinancing is paying off your existing land loan with a new mortgage, so you basically have a new loan. Most landowners refinance to take advantage of lower interest rates, allowing them to save significantly on interest payments in the long term.

Refinancing makes more sense for borrowers who can reduce their current rate by at least 1%. Refinancing at a lower rate means you can lower your monthly repayments by extending the loan term or shortening the loan term to pay off the loan faster.

You can also consider refinancing your land loan if:

• You want to adjust your land loan payment schedule
• You’d like to alter the terms of the existing land loan
• You want to shift from an adjustable to a fixed-rate land loan
• You’re hoping to secure some amount in cash to cater to personal financial obligations

Regardless of the reason for refinancing, it’s crucial to learn how to do it the right way.

So, how does land loan refinancing work?

Generally, refinancing entails replacing the debt on your current mortgage. When you refinance, you don’t actually receive the funds from the loan, unless it’s a cash-out refinancing. Instead, the lender handles your transactions behind the scenes.

That is, the lender uses the new loan amount to pay off your existing land loan. After closing, you’ll start servicing the new loan. You can choose a different rate and loan term on the new mortgage to make it more affordable or enable you to meet your other financial goals.

Types of Land Loan Refinancing

There are three main types of land loan refinancing:

• Rate-and-term refinancing
• Cash-out refinancing
• Cash-in refinancing

Rate-and-term refinancing

Rate-and-term refinancing is the most common type of refinancing. It allows the landowner to adjust their current loan rate or term, or both. For example, the borrower can take advantage of decreasing market interest rates by initiating a refinancing with an adjusted rate.

Alternatively, the borrower can refinance from a 25-year fixed-rate land loan with a high-interest rate to a 15-year fixed loan with a lower rate. Shortening the loan term means paying higher monthly interest, but a lower amount of total interest paid over the loan’s repayment period.

Cash-out refinancing

In a cash-out refinancing arrangement, the borrower takes out a new loan on the property for a larger sum than the balance on the original loan. This type of refinancing is ideal if your land has equity which can be exchanged for a higher loan amount.

This plan attracts a higher interest rate compared to rate-and-term refinancing but gives the borrower instant access to cash while still maintaining ownership of the asset.

In simple terms, a cash-out refinance lets you use your asset as collateral for a new loan and remain with some cash. As a result, you end up having a larger loan amount than what you currently owe. It can be helpful when you want to acquire funds for emergencies or other expenses.

Let’s simplify it even further using this example:

• Land value: $150,000
• Current loan balance: $ $50,000
• New loan balance: $100,000
• Cash received at closing: $50,000 (less closing costs)

Cash-in refinancing

Cash-in refinancing is the opposite of a cash-out refinance. The borrower can pay some portion of the loan for a lower loan-to-value (LTV) ratio. This leaves the borrower with a lower loan balance than the initial loan, resulting in lower interest rates or lower monthly payments.

How to Refinance a Land Loan

Typically, when you apply for a land loan refinancing, the process follows the same basic requirements as when applying for a land loan, such as creditworthiness and repayment status. But, much emphasis is placed on the land’s location and your plans for utilizing the land.

Generally, you’ll need to meet certain requirements to refinance, which include:

• Duly prepared financial documents, which should include tax returns from the past three years, an updated balance sheet, working capital, and any other additional documents.
• A compilation of your current investments, including total acres (owned or rented), rent amounts, average yield (if you farm), and projected cash flow.
• Your credit rating should be at least 760 to qualify for the lowest interest.
• A detailed plan for the intended use of the land.
• Down payment percentage. Your loan officer can help you determine the amount you need to put down.

It’s also advisable to know your debt-to-income ratio. This is the percentage that shows lenders the total amount of money you spend paying off debts versus how much is coming into your household. The lender won’t refinance you if they determine you’re taking on more debt than you can handle.

Before you approach your preferred lender to initiate a refinancing process, here are a few important tips to consider:

• Compare the new loan terms, that is, the rate and number of years to repay the loan, to your current loan terms. You may find it more beneficial to adjust the loan rate or length, or both.
• You may want to draw detailed development plans if your original loan is a raw land loan. Raw land is completely undeveloped land, meaning it has no roads, sewers, or electricity. For this reason, lenders may find it more difficult to provide financing. A solid, detailed plan showing how you intend to develop the land shows you’re committed to the project and, hence, pose less risk.
• For semi-improved land – one which has electricity and sewer access – find a surveyor to prove it. Lenders will be more willing to finance land that can be developed and may even offer lower rates.
• A good rule of thumb is to pay points upfront instead of letting the costs be incorporated with the new loan – doing so will result in lower interest.
• Determine how much it costs to refinance. Inquire about the closing costs and all other fees involved.

Wrapping Up

Refinancing a land loan offers you the opportunity to get a lower interest rate or cash out accumulated equity on your asset. Before refinancing, shop for lenders to get the best deal. Of course, the monthly payments and interest rate should be lower than your existing land loan for the refinance to make financial sense.

Remember, your land will serve as collateral. Therefore, carefully consider your options before making such a huge commitment since you risk losing the property if you’re unable to repay the loan in the future.