First Published January 18, 2023 | Updated August 7, 2024
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 land you own 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 pledging your land, it’s important to understand the advantages and disadvantages of collateral loans.
What Are Collateral Loans?
When it comes to personal loans, using land as collateral may not be as common as it is for mortgages or business loans. Personal loans are typically unsecured, meaning they do not require collateral. Collateral loans are often called secured loans, as your own property guarantees the loan. 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 and better terms, but they can come in larger amounts compared to unsecured loans, which rely only on your credit history and income.
The property used for collateral can be anything from a car or house to an expensive ring or investment portfolio. However, it is possible, and there may be situations where using land as collateral for a personal loan could be a useful option.
How Is Land Considered 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.
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. Condition, position, location, and environmental factors often impact value. 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 may be impacted.
The appraiser will also assess the viability of the land as collateral based on additional factors, including:
Title and Ownership: Clear ownership and title to the land are crucial for using it as collateral. Lenders will want to ensure that there are no legal disputes or encumbrances on the land that could affect its value or ownership.
Loan-to-Value Ratio: Lenders often have a loan-to-value (LTV) ratio requirement for using land as collateral. This means that they will only lend a certain percentage of the land’s appraised value. For example, if the LTV ratio is 80%, you can potentially borrow up to 80% of the land’s appraised value.
Lender’s Policies: Each lender may have specific policies and criteria when it comes to using land as collateral. It is important to research and communicate with potential lenders to understand their requirements and terms.
Though these are the most common factors, note that eligibility and land value may vary depending on additional terms and circumstances.
What Types of Loans Allow 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, including the size of the land, the value of any natural resources on it, and the history of use of the land. If a revolving line of credit is preferable to a lump sum, land equity lines of credit are also popular options.
Land Loans
Land loans, often called lot loans, are used to buy a lot of land that you, or in many 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 may require 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. A good credit score and a large down payment are typically required.
- Improved Land Loans – The last type of land loan is improved land loans, which are loans on land with access to roads and utilities like water and electricity. Since the resources are ready to go, improved land tends to be more valuable than unimproved land or raw land, and this also allows them to potentially qualify for better rates.
Construction Loans
Construction loans are loans for individuals who are ready to build their homes on the land or need to make improvements. They are typically short-term loans with relatively higher interest rates, meant to be completed in under a year. With a construction loan, though, you may 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 may require your building plans and your financial records, in addition to an estimated budget and timeline.
Benefits of Using Land as Collateral
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 sell 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 of using land as collateral is that loan amounts can be much higher than those of 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 more likely to qualify for a higher loan amount than you would with other loans.
Drawbacks of Using Land for Collateral
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 if you are currently using a loan to pay for the land in question, it may affect your debt-to-income ratio, which will impact the rates and terms your lender may be willing to offer.
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.
Final Considerations
Land can be a useful tool for obtaining 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 them 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 depends on several factors, including whether 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, we encourage you to speak to your financial, legal, or tax advisor about your circumstances, and contact your local lender for options available to you.
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