With this in mind, let's go through some figures to illustrate. Picking some numbers out of the air, let's say the home is worth $300000. His bank needs him to have 7% equity in order to protect their investment in him. If he is buying the entire property for $530000, they can then loan $493000. Maybe they are generous on the home appraisal and give it $350000. That still represents a shortfall of $143000. The land is easily worth that, and far more, so there is no problem IF they loaned on the land as well. But if they don’t; guess who makes up that shortfall? He does. So, now instead of needing only 7% down ($37000), he suddenly needs $180000 down. If they will loan on a few extra acres or the outbuildings (this varies), that number can come down a little bit. On the other hand, if they are less generous on the home appraisal, his down payment goes up correspondingly.
Now, compare a bank that will lend on land. They may require 20 or 25% down. Let's use 25%. In our example; that’s $132500 down. Suddenly the bank everyone rejects looks a lot better. In actuality it is more complicated than this. I have not discussed interest rates and length of amortization. Incidentally, length of amortization usually has a greater influence upon lowering your monthly payments than the interest rates do. It also has the greater influence upon how much you ultimately pay.
The failure of most banks to loan on land initially puzzled me as you’d think it would be the safest. Land does not burn, blow down or collapse under snow; buildings can and do. Yes, land can be clearcut or allowed to grow fallow but that kind of depreciation pales when compared to what can happen to buildings. That’s why no one gets insurance for the destruction of land. But there are other things going on. Big banks are great bean counters, the more so the bigger these banks get. When you get big, you start making regulations and you try to make the art of lending into a science. That leads to fitting square pegs into round holes. Farms are square pegs. The vast majority of real estate transactions are for homes, with businesses a poor second, so you plan for round pegs. Added to this is the fact that their loan officers don’t know or understand farms, nor are they equipped to determine how farming will affect an applicant's ability to service the loan. It’s bad business to loan on something you do not understand, so they don't.
Complicating things and adding to this square peg/round hole phenomenon are Federal regulations, the HUD thing. If a bank is going to sell its loans to another institution, they have to comply with HUD regulations. Farms don’t fit. HUD deals with homes, not farms, so that means a bank has to be prepared to keep any land or farm loans in house. That happens less and less anymore. Many banks sell ALL their loans. They have become mortgage originators not servicers. I think that trend is ultimately detrimental to our banking system, but we won’t go there now; others disagree and they are in positions of power that I sure don’t occupy. I have seen so many absolutely stupid mistakes big banks make, so many great opportunities missed due to the way their regulations tie the hands of their personnel. They are apparently willing to lose out 5% (or whatever) of the time to be right on the other 95%. They don’t worry about being right 100%.