Even for the most financially healthy people, loans can sometimes be difficult to obtain, especially larger ones. However, if you need a loan, options are available to help you get one, including using owned land or land that was gifted to you as collateral.
By using land as collateral for a loan, lenders are more likely to take on more risky customers, potentially at lower interest rates. However, you may lose your land if you cannot pay the loan back. Before giving up your land, it’s important to understand the advantages and disadvantages of collateral loans.
What are Collateral Loans?
Collateral loans are often called secured loans, as your own property guarantees the loan. The property can be anything from a car or house to an expensive ring or investment portfolio. Land that you own is commonly used as collateral. Mortgages are also considered collateral loans, with the house in question being the property.
If you do not pay on your collateral loan, the lender can seize the property to pay off the remainder of the loan. However, the guarantee makes lenders feel more confident in approving collateral loans. Collateral loans not only tend to have lower interest rates, but they can come in larger amounts compared to unsecured loans, which rely only on your credit history and income.
What Does it Mean to Use Land as Collateral for a Loan?
One way to secure a collateral loan is by using any land you own, including construction loans and even personal loans, if the lender approves you. To use the land as collateral, the land must have an equity value that is equal to or exceeds that of the loan amount. You must own it outright unless it is specifically a land loan.
Once a lender approves the land as collateral, a lien will be put on the land. The lien will be released as soon as the loan is paid in full. If the loan is not paid on time or defaults, the lender can seize the land, as set forth in the contract.
Understanding land value
To find the value of your land, the lender will typically require an appraisal from a real estate appraiser. The appraiser will assess the land value based on several factors, such as its condition, position, location, and environmental factors. For example, land further away from cities may be valued less than that near a populated area. If the land is near a city and the city has a restriction on it, such as an environmental protection act, its value would be impacted.
What Types of Loans Can Use Land as Collateral?
Depending on your needs and your lender, you can use land as collateral for a few different types of loans. The most common use of land collateral is for a land equity loan. Land can also be used as collateral for a personal loan, which can be used for almost anything.
Land equity loans
Land equity loans work similarly to home equity loans; they use the equity of the land you own to borrow against. The amount of equity the land has will be determined by several factors ranging from the size of the land, if there are natural resources on it, and even the history of the land and how it was used in the past.
To obtain a land equity loan, the land must be owned in full without debt. Land equity loans are available as a cash-out refinance, a land equity line of credit, and a construction loan.
Land loans, often called lot loans, are used to buy a lot of land that you, or in most cases, a building company, are interested in building on. For these loans, you do not need to currently own the land, but the land the loan is for will act as the collateral, just as with purchasing a house. If the mortgage is not paid, you may lose the house; if the land loan is not paid, you could lose the land.
Land loans are best suited for those who are looking at long-term projects, such as a large community or business area, that will take over a year. Those who intend to start building right away on the land should look into construction loans, which are for short-term projects.
Several types of land loans are available, including personal loans, USDA loans, SBA loans, and traditional bank or credit land loans. Further, your land loan may be determined by the type of land it is.
- Raw Land – When you think of a lot of land, you may be thinking of raw land. Raw land is undeveloped land without utilities or roads. These loans tend to be harder to obtain because you must have detailed and committed plans to use the land and will need a large down payment.
- Unimproved Land Loans – Unimproved land is land with a few utilities or roads nearby. It’s not completely void of any human touch, but it needs improvement, such as sewers or electricity, to make it livable. These types of loans can be as difficult to get as raw land loans, but they are seen as less risky. You will need a good credit score and a large down payment.
- Improved Land Loans – The last type of land loan is improved land loans, which is land that has access to roads and utilities like water and electricity. Improved land loans tend to be more costly than unimproved land loans or raw land since the resources are ready to go, but this also allows them to have lower interest rates.
Construction loans are loans for individuals who are ready to build their homes on the land or need to make improvements. They are short-term loans with higher interest rates and are meant to be completed in under a year. With a construction loan, though, you will only pay interest on the funds that are used rather than the lump sum.
Materials, labor, and even land can be purchased with construction loans. If you already own the land you plan to build on, you can use it as collateral. To obtain a construction loan, your lender will need your building plans and your financial records, in addition to an estimated budget and timeline.
Benefits of Using Land as Collateral for a Loan
Using land as collateral for a loan comes with many benefits, both for the lender and the borrower. As the land is used as collateral, there is less risk of the loan defaulting. The lenders can seize the land if the borrower does not pay on the loan and use the land to pay off the remaining balance.
Due to the lower risk, loans that use land as collateral are often easier to obtain than unsecured loans, even for those with lower credit scores.
Another benefit to using land as collateral is that the loan amounts can be much higher than other unsecured loans, which are often capped at lower amounts. If you own land and want to build your dream home on it, you are less likely to be restricted by the loan amount than you would with other loans.
Con of Using Land for Collateral for a Loan
Although there are great benefits to using land for collateral against a loan, there are a few items to consider before committing to it.
The first is that you must own the land or be using a loan to buy the land in the case of a land loan. If you have land but are still paying off another loan for it, you cannot take collateral out against it. Many people may not own land, making this option unavailable to them. Or, if they are looking to get a land loan, they may not have the high credit score and large down payment that is needed to be approved for it.
The other and most obvious con to using land as collateral is that you risk losing the land if you cannot pay on the loan. The same is true of any loan where you must put something as collateral. Paying your loan on time every time is important to avoid defaulting. If you cannot pay the loan or are running into unforeseen circumstances, it’s important to speak to your lender. They may be willing to work with you to move payment dates.
Should You Use Land as Collateral for a Loan?
Land can be a useful tool to obtain a loan that would otherwise be out of reach for many people if they have the opportunity. Many loans, including land loans and construction loans, can be secured with land, making it less risky for lenders and allowing those with average credit to be approved.
Whether or not you should use land as collateral for a loan is dependent on a few factors, including if you own land. If you own land and want a loan to build or finance another project, you may be able to secure a loan with low interest and a higher amount. However, you also put your land at risk if you don’t pay the loan back on time. If you are on the fence, you can speak to one of our lenders to discuss your options.
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