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.
Using your home as collateral for a loan may seem like an easy way to get quick funds. But pledging your house comes with considerable risks that homeowners should carefully evaluate.
This comprehensive guide examines when and how to use your real estate as collateral the types of loans available benefits and drawbacks, and steps to protect yourself when leveraging home equity.
What Does It Mean to Use a Home as Collateral?
Collateral refers to a borrower’s asset that secures a loan and can be seized in case of default. When you use your house as collateral, it means you allow the lender to claim your home if you fail to repay the loan as per the terms.
The lender places a lien on the property till the debt is settled. If you cannot pay back, they can force a sale to recover their money. So your home is at risk if you default.
When Is Using a Home as Collateral a Good Idea?
You may consider using home equity as collateral in situations like
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Funding education: Home equity loans allow you to pay for college tuition, textbooks, room and board without impacting cash flow.
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Starting a business: With limited business credit, pledging your home allows entrepreneurs to get capital to launch or expand.
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Consolidating high-interest debt: Combine multiple credits card balances into a lower fixed-rate home equity loan or line of credit.
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Home renovations: Remodeling projects or repairs like a new kitchen or roof upgrade can be financed by tapping home equity.
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Medical expenses: Major medical events and procedures can be paid for by borrowing against home value instead of savings.
However, only use home equity if you have significant built-up value and can comfortably handle added mortgage payments.
What Types of Collateral Loans Are Available?
If you decide to use your house as collateral, consider these loan products:
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Home Equity Loan: Offers lump-sum amount at a fixed interest rate and fixed monthly payments for a set repayment term. Good for one-time major expenses.
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Home Equity Line of Credit (HELOC): Provides access to revolving credit line where you can draw as needed. Has variable interest rates and flexibility to only pay interest on what you use.
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Cash-Out Refinance: Converts existing mortgage into a larger loan to tap extra equity while refinancing. Results in higher loan balance and payments.
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Reverse Mortgage: Allows seniors 60+ to access home equity without repayment as long as they live in the home. Must be repaid when last owner moves out or dies.
Consider both loan amount needed and your financial ability to manage higher monthly payments before choosing a product.
What Are the Pros of Using Your Home as Collateral?
Some benefits include:
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Access funds locked in home equity without selling the property.
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Potentially lower rates compared to unsecured loans like personal loans or credit cards.
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Interest may be tax deductible up to certain limits, providing savings.
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Flexible repayment options depending on the loan product selected.
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Ability to build credit through responsible collateral loan management, helping mortgage rates later.
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Retain ownership and control over your home despite using it as collateral.
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Lower payments than selling home and downsizing to repay debts through cash-out.
What Are the Cons of Pledging Your Home as Collateral?
There are also serious downsides:
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Risk of foreclosure if you default on collateral loan terms, resulting in loss of home.
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Difficulty getting mortgages in the future after taking out large home equity loans.
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Fees and closing costs associated with setting up the loan can be expensive.
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Rising interest costs if rates fluctuate in case of adjustable-rate products.
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Reduction in equity as larger loans eat away at the amount available for emergencies.
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Tapping retirement funds early removes home value meant to supplement retirement income.
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Potential decline in property value makes it riskier to borrow large sums.
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Loss of property tax deduction in case you convert primary home to rental after moving out.
What Are Ways to Protect Yourself When Using Home Equity as Collateral?
If you use your real estate as collateral, reduce risk by:
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Borrowing no more than 80% of your total home value so adequate equity remains.
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Selecting fixed interest rate products so your payments remain stable.
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Opting for shorter repayment terms so you pay less interest over time.
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Making payments on time to avoid defaulting and damaging credit score.
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Investing borrowed funds responsibly to generate returns and facilitate repayment.
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Avoiding spending collateral loan amount on depreciating assets like cars.
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Maintaining home insurance to rebuild value in case of events like fires or floods.
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Holding savings to pay off loan balance in case of job loss or other hardship.
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Seeking professional advice from a loan officer or financial planner before pledging home.
What Are Some Alternatives to Using Your Home as Collateral?
Instead of putting your property at risk, consider:
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Taking out a personal loan that does not use collateral.
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Asking family or friends for a loan with clear terms.
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Withdrawing from your 401(k) or IRA retirement accounts.
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Liquidating investments in stocks, bonds, or mutual funds.
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Selling valuables that you own free and clear.
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Downsizing to a smaller living space to reduce expenses.
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Applying for scholarships, grants, or financial aid for education.
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Fundraising via crowdsourcing platforms.
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Seeking aid from nonprofit organizations or charities.
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Setting up payment plans with healthcare providers.
Questions to Ask Before You Pledge Your Home
Carefully consider these key questions if you plan to use your real estate as collateral:
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How much equity do I have available? What is my loan-to-value ratio?
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How might borrowing against my home impact my long-term goals?
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What happens if the value of my home declines after taking out a collateral loan?
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Will future mortgage lenders view my loan negatively? Will it impact ability to refinance?
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What fees and closing costs are associated with this loan product?
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Do I have enough cash flow to manage potentially higher monthly payments?
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What alternatives do I have for accessing funds without putting my home at risk?
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Am I comfortable with the worst-case scenario of losing my home if I default?
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What steps can I take to protect myself and minimize risk?
The Bottom Line – Is Using Your Home as Loan Collateral Smart?
Tapping home equity can provide funds for major expenses but also puts your most valuable asset in jeopardy. Carefully assess your specific situation, loan product fit, and repayment ability before using your property as collateral. Seek professional guidance to make an informed choice.
With proper precautions, collateral loans allow you to strategically leverage home value. But they require fiscal discipline so you don’t end up losing your home. Weigh the benefits against worst-case scenarios to decide if pledging your house makes sense.
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 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.
Using Your House As Collateral
FAQ
How do I use my house as collateral for a loan?
How much can I borrow using my home as collateral?
Is it a good idea to use your house as collateral?
Can I get a loan with bad credit using my house as collateral?
What is the difference between a mortgage and collateral?
A mortgage is a type of loan for financing the purchase of a property. Collateral is an asset that provides the backing for the loan, any sort of loan. You almost always need collateral to get a mortgage, and that collateral is almost always the property you’re buying with the loan.
Should I use my home as collateral?
If you feel like you have good reasons for using your home as collateral, proceed with caution and keep the following guidance in mind. Jay Garvens, a business development manager for Churchill Mortgage in Colorado Springs, CO, advises potential borrowers to make sure they can pay off and close out the loan within six to 18 months.
Can a loan be used as collateral for a mortgage?
Collateral can be used for loans, including mortgages. It doesn’t necessarily have to be property; some lenders let borrowers use their savings accounts or certificates of deposits as collateral. If you don’t repay the money you borrowed, the lender can take your loan instead.
Can a home be used as collateral for home equity financing?
Refinancing your home, getting a second mortgage, taking out a home equity loan, or getting a HELOC are common ways people use a home as collateral for home equity financing. But if you can’t repay the financing, you could lose your home and any equity you’ve built up.