Using A Home Equity Loan for Land Purchase: A 2023 Guide

Purchasing land to build a home on is an attractive option for many buyers in today’s competitive housing market. With low inventory constraining choices the ability to construct a customized house on an ideal plot of land is appealing. However, buying and developing vacant land requires significant upfront costs that may be prohibitive for some buyers. This is where a home equity loan can help.

A home equity loan leverages the equity built up in your current home to provide funds that can be used for any purpose – including purchasing land. With interest rates still near historic lows, a home equity loan offers homeowners an affordable way to buy and develop property.

In this guide, we’ll explain everything you need to know about using a home equity loan for a land purchase, including:

• How home equity loans work
• Pros and cons of using home equity to buy land
• Loan amount and rates
• Qualification requirements
• Alternative financing options
• Tips for buying land with a home equity loan

How Does a Home Equity Loan Work?

A home equity loan is a type of second mortgage that allows you to borrow against the equity in your home. Equity is defined as the current market value of your home minus any outstanding mortgage debt. For example, if your home is worth $300,000 and you owe $180,000 on your mortgage, your equity is $120,000.

With a home equity loan, you’re essentially using your home as collateral for the loan. The lender places a second lien on your property behind your primary mortgage. This allows you to leverage your equity to access funds for large expenses like a land purchase.

Home equity loans provide lump sum financing, meaning you receive the full loan amount upfront in a single disbursement. You make fixed monthly payments over a set repayment term, usually between 10-30 years. Interest rates are fixed as well, helping you lock in low rates for the duration of the loan.

Pros and Cons of Using Home Equity to Buy Land

Utilizing home equity to purchase land has several notable advantages

Pros

• Interest rates are low, currently averaging around 5% to 7% for home equity loans
• Payments are predictable with fixed rates and terms
• Interest may be tax deductible (consult a tax advisor)
• Fast access to lump sum financing
• Requirements are often less stringent than other loan types

However, there are some potential drawbacks to consider as well:

Cons

• Closing costs and fees can be high, around 2% to 5% of the loan amount
• Your home acts as collateral and could be foreclosed on if you default
• Loan amounts are capped at 85% of your total equity
• Debt-to-income ratios may limit loan eligibility if you have existing mortgages
• Interest rates are higher than primary mortgages
• You lose equity when tapping into your home’s value

As with any major financing decision, you’ll want to think carefully before using home equity to facilitate a land purchase Make sure you’re comfortable with the risks and can manage the additional debt load.

How Much Can You Borrow? What Are Current Rates?

The amount you can borrow with a home equity loan depends on how much equity you currently have built up in your home. Most lenders will approve loans up to 85% of your total equity.

For example, if your home is valued at $500,000 and you owe $250,000 on your primary mortgage, your equity is $250,000. With the 85% limit, you could qualify for a home equity loan up to $212,500.

Minimum loan amounts are usually around $15,000 to $25,000. However, to buy and develop land you’ll likely need to borrow a more substantial sum.

Current interest rates on 10-year home equity loans average around 5% to 6%, while 15- to 30-year loans are closer to 6% to 7%. Rates are near historic lows, making now an opportune time to leverage home equity.

Of course, actual loan amounts and rates vary by lender and are based on individual financial factors like your credit score, debt-to-income ratio, and loan-to-value ratio. Shop around with multiple lenders to find the best terms. Federal credit unions often have the lowest rates.

Qualification Criteria: What Does It Take to Get Approved?

When applying for a home equity loan, lenders will evaluate your overall financial profile, including:

• Credit score – Minimum scores of 620 to 640 are common requirements. Higher scores qualify you for lower rates.

• Loan-to-value (LTV) ratio – Compares loan amount to home value. Lenders limit lending to 85% LTV or less.

• Debt-to-income (DTI) ratio – Monthly debt payments divided by gross monthly income. Limits are typically around 43% to 50%.

• Equity – More equity lowers risk for lenders. At least 15% to 20% is recommended.

• Collateral – Your home acts as security for the loan. Lenders want sufficient equity cushion.

Providing tax returns, bank statements, a credit report, and evidence of income are usually required during underwriting. Expect a similar experience to applying for a primary mortgage.

Meeting standard eligibility criteria along with having substantial home equity should position you to qualify and get approved.

Alternative Financing Options Beyond Home Equity

If you don’t have sufficient home equity or are uncomfortable tapping into your home’s value, alternative options exist for financing a land purchase, such as:

• Personal loans – Unsecured loans up to $100k for any purpose. Higher rates but home isn’t collateral.

• Construction loans – Designed specifically for building on vacant land. Interest-only payments during building.

• Land loans – Financing offered by some lenders and developers to buy plots of land. More stringent eligibility.

• HELOCs – Revolving home equity line of credit offers flexible borrowing. Only pay interest on what you use.

• Hard money loans – Asset-based financing from private lenders at higher rates for short terms.

• Seller financing – Seller carries the loan instead of a bank. Down payment direct to seller.

Each option has pros and cons to weigh based on your financial situation and the specifics of your land purchase. Shop around and compare financing alternatives to make the right choice.

8 Tips for Buying Land with a Home Equity Loan

If you determine a home equity loan is the right financing vehicle for your land purchase, here are some tips to ensure everything goes smoothly:

1. Check property deed restrictions – Ensure no prohibitions on building or land usage before purchasing.

2. Hire a real estate attorney – Legal expertise helps navigate the title search, deed transfer, contracts.

3. Get the land surveyed – Identify exact property boundaries and check for encroachments.

4. Inspect the property – Look for any environmental issues or things impacting building plans.

5. Have a site plan created – Helps visualize home layout and identify any needed land improvements.

6. Calculate all costs – Purchase price, survey, title work, permits, land clearing, utility connections.

7. Get cost estimates for construction – Helps determine how much financing you’ll really need.

8. Shop multiple lenders for financing – Compare loan amounts, rates, terms, and fees.

Doing your due diligence on the front end will help ensure a smooth land purchase and development project. Just be sure to get pre-approved for financing before making an offer, as private land sales often entail competing bids.

The Bottom Line – Is a Home Equity Loan Right for You?

Tapping home equity via a second mortgage can provide an affordable way to purchase and develop vacant land for future home construction. Before pursuing this route, be sure you’re comfortable taking on the risks that come with borrowing against your home’s value.

Run the numbers to get a true sense of costs – both for the land itself and building a new home. And explore all your financing options, as a home equity loan isn’t necessarily the only or best choice. But with current low rates, it can be a viable option for making a land purchase more accessible.