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.
A collateral loan is a type of secured loan where the borrower pledges an asset as security for the loan. If the borrower fails to repay the loan, the lender can seize the pledged asset. Collateral loans are commonly used when borrowing money to purchase real estate, vehicles, equipment and other high-value assets.
One of the most common types of collateral loans is a mortgage, where the purchased property serves as collateral for the loan. Borrowers looking to take out a collateral loan on an existing property they already own have options as well. These types of loans allow homeowners to leverage their home equity for access to funds while avoiding the need to sell their property.
In this comprehensive guide, we’ll cover everything you need to know about collateral loans on property including
- What is a collateral loan on property?
- How do collateral loans on property work?
- What are the benefits and drawbacks?
- What types of property can be used as collateral?
- What are the requirements to qualify?
- How much can you borrow?
- What are the interest rates and fees?
- What is the process of getting a collateral loan on property?
- What happens if you default on the loan?
- Alternatives to consider
What is a Collateral Loan on Property?
A collateral loan on property uses real estate as security for a loan. The property could be the home you live in, a rental property, vacant land, commercial real estate or any other type of real property.
With a collateral loan, the lender places a lien against the property If the borrower defaults, the lender can foreclose and take possession of the home through a legal process The property serves as collateral in case the borrower fails to repay the loan as agreed.
Collateral loans allow borrowers to tap into their property’s equity. Equity is defined as the current market value of the home minus any outstanding mortgage debt. For example, if your home is worth $300,000 and you owe $180,000 on your mortgage, you have $120,000 in equity. With a collateral loan, you can leverage this equity to obtain financing.
How Do Collateral Loans on Property Work?
Collateral loans on property function similarly to a mortgage or home equity loan The major steps include
-
Application – You apply for the loan by providing information on the property, your income, expenses and credit history. The lender uses this to evaluate eligibility.
-
Appraisal – The lender will order a home appraisal to verify the property’s current market value. This determines the amount you can borrow.
-
Underwriting – The lender analyzes your application according to loan qualification guidelines regarding income, credit score, debt-to-income ratio and loan-to-value ratio.
-
Approval – If approved, you’ll receive a loan estimate outlining the interest rate, fees, loan amount and repayment terms.
-
Closing – During closing, you review and sign loan documents. The lender usually requires an attorney to oversee the process.
-
Funding – Once you’ve signed the paperwork, the lender will fund the loan and deposit the money into your specified account, minus any fees and closing costs.
-
Repayment – You repay the loan in monthly installments over a set period, usually 5 to 30 years. A portion goes toward interest and the rest reduces the principal balance.
-
Lien Release – After repaying the loan in full, the lender releases the lien and sends paperwork showing the property is free of any security interest.
Benefits of Collateral Loans on Property
Collateral loans allow homeowners to leverage the existing value in their property to access funds. Some key advantages include:
-
Competitive rates – Collateral loans often have lower interest rates than unsecured loan options. The property secures the debt, reducing the lender’s risk.
-
Larger loan amounts – You may qualify to borrow more with a collateral loan compared to personal loans or other unsecured financing options.
-
Flexible terms – Repayment terms range from several months to over 30 years. You can usually choose an option that aligns with your budget and goals.
-
Access home equity – Tap into your property’s equity without having to sell. Use the funds however you want.
-
Potentially tax deductible – You may be able to deduct interest paid on the loan from your taxes, which can provide savings.
Drawbacks of Collateral Loans on Property
While collateral loans offer advantages, some key downsides to consider include:
-
Risk of foreclosure – If you default, you could lose your property to foreclosure. This is the most serious risk.
-
Closing costs – Lenders charge loan origination and other fees that add to your total costs. Closing costs can range from 2% to 5% of the loan amount.
-
Prepayment penalties – Some lenders impose a fee if you repay the loan early. Make sure you understand any prepayment penalty conditions.
-
House price decline – If property values drop, your home could fall into a negative equity position since the loan balance may exceed the property’s worth.
-
Complex process – Obtaining a collateral loan involves more steps, requirements and costs compared to unsecured loan options.
What Types of Property Can Be Used as Collateral?
You can use several types of property as collateral when taking out a secured loan:
-
Primary residence – Your primary home where you currently live can serve as collateral. Primary residence loans often have the lowest rates.
-
Second home – Loans against a second home or vacation property you own are possible as well. Rates are usually higher than on primary residences.
-
Investment property – Rental properties, apartment buildings, vacation rentals and other investment real estate can be used as collateral. Eligibility depends on equity, income and credit.
-
Land – Loans against undeveloped land are considered higher risk, so may have strict requirements. But loans on land are possible.
-
Commercial property – Office buildings, retail space, warehouses and other commercial real estate can be pledged as collateral with the right lender.
Always check specific lender guidelines, as some may limit collateral loans to only owner-occupied primary residences. Also, second homes and investment properties usually come with higher interest rates.
Collateral Loan Requirements
To qualify for a collateral loan on property, lenders analyze these key factors:
-
Credit score – Minimum scores vary by lender but often start around 580 to 620 for collateral loans. The higher your score, the better the chances for approval.
-
Debt-to-income ratio – Lenders look at your total monthly debt payments divided by gross monthly income. Common DTI requirements fall between 36% to 50%.
-
Loan-to-value ratio – The loan amount compared to the property’s appraised value. For example, a $100,000 loan on a $200,000 home is a 50% LTV. Many lenders cap LTVs between 70% to 90%.
-
Equity – The property must have sufficient equity to qualify. You’ll usually need at least 15% to 20% equity, possibly more for investment properties or riskier loan types.
-
Property value – The home must appraise for at least the loan amount requested. Higher values allow you to qualify for larger loan amounts.
-
Income and employment – Most lenders require steady income and employment to comfortably handle the loan payments. Two years of consistent income is common.
How Much Can You Borrow With a Collateral Loan?
The loan amount you can qualify for depends on factors like the property value, your equity stake, income and creditworthiness. But there are some general guidelines on loan amounts:
- Home equity loan – Usually up to 85% of your home equity
- Cash-out refinance – Up to 80% of the home’s value
- HELOC – Often 70% to 80% of home equity
- Hard money loans – Around 60% to 75% of the property’s value
Always account for any existing mortgages or liens on the property first. For example, if you have a $100,000 property with a $50,000 mortgage, you may qualify for around $35,000 as a home equity loan.
Interest Rates on Collateral Loans
Interest rates on collateral loans vary depending on the type of loan, credit score, loan-to-value ratio and overall qualifications. Here are some average rate ranges:
- Home equity loan – 7% to 15%
- Cash-out refinance – 4% to 8%
- HELOC – 5% to 11%
- Hard money loans – 9% to 15%+
In general, better credit and lower LTVs qualify you for the lowest rates. Shop multiple lenders to compare your specific interest rate offers. Secured loans almost always have lower rates than unsecured personal loans or credit cards.
Fees Charged on Collateral Loans
When taking out a collateral loan
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.
What Is Collateral Mortgage
FAQ
How do I borrow money from property as collateral?
Is a collateral loan worth it?
What property is accepted as collateral?
Can I get a loan with bad credit using my house as collateral?
What is a collateral loan?
A collateral loan is a secured loan that requires the borrower to provide an asset as security for repayment. With these loans, a lender can take possession of your property—the loan collateral—if you fail to repay the loan. Common examples of collateral loans include mortgages, auto loans and secured personal loans.
Can I get a loan using my house as collateral?
Yes, you can get a loan using your house as collateral.This is often referred to as a **Home Equity Loan**.Here’s how it works: – A home equity loan lets you borrow money using your home as collateral.
What is the difference between a mortgage and collateral?
A mortgage is a type of loan that you can use to finance the purchase of a property. Collateral is an asset that provides the backing for a 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.
Where can I get a collateral loan?
Collateral loans are available through most lenders. Remember, the loan type can influence where you can receive a specific secured loan. For instance, some lenders don’t offer mortgages and home equity loans. In addition, you can shop for auto loans with conventional lenders and car dealerships.