How to Use Land as Collateral for a Loan

Using land as collateral for a loan can be a great way to access funds especially if you have equity built up in property you own. With land acting as security for the loan, lenders often offer more favorable terms compared to unsecured loans. However putting up land as collateral does come with some risks that you’ll want to fully understand before moving forward. This guide will walk through everything you need to know about using land as collateral for a loan.

What is Collateral and How Does it Work?

Collateral refers to an asset that a borrower pledges to a lender to secure a loan. If the borrower defaults on repaying the loan, the lender can seize the collateral asset and sell it to recover their money Common types of collateral include cars, jewelry, investment accounts, and real estate

When land is used as collateral, the property itself guarantees repayment of the loan. If the borrower stops making payments, the lender can foreclose on the land, take ownership of it, and sell it to recoup their losses.

Using collateral benefits borrowers because it makes lenders feel more secure, meaning they may offer lower interest rates and be more likely to approve applicants with less-than-perfect credit. For lenders, collateral reduces risk because they know they can take the land if borrowers don’t repay.

How to Use Land as Collateral for a Loan

If you want to use land as collateral for a loan, there are a few key steps:

• You must own the land outright – You can’t use land as collateral if you still have an outstanding mortgage or lien on the property. You need clear, unencumbered ownership.

• The land must have sufficient equity – Lenders will require that the land has enough built-up equity to sufficiently secure the loan. Often a loan-to-value ratio of 65-85% is required.

• Get the land appraised – The lender will require a formal appraisal to determine the property’s current market value. This establishes how much equity is available.

• The lender places a lien on the land – This gives them the legal right to take ownership of the land if you default on the loan payments.

• Make payments on time – To avoid foreclosure, carefully adhere to the repayment schedule in your loan agreement.

• The lien gets removed once paid off – When the loan has been fully repaid, the lender will remove the lien on your land.

Types of Loans to Use with Land as Collateral

There are several common loan types that allow the use of land as collateral:

Land Equity Loans

Similar to home equity loans, these loans let you leverage the equity built up in land you own. The equity gets converted to a cash payout you can use for any purpose.

Land Equity Lines of Credit

Functions like a credit card but uses land as collateral. You can access cash up to a set limit and only pay interest on what you use.

Cash-Out Land Refinancing

You take out a new loan using your land as collateral, pay off your old land loan, and receive the difference in cash.

Land Loans

Also called lot loans, these finance the purchase of land. The land being purchased serves as collateral for the loan.

Construction Loans

Short-term financing to fund construction projects on land you already own free and clear. The land collateralizes the construction loan.

Pros and Cons of Using Land as Collateral

Pros

• May qualify for a larger loan amount
• Potential to receive better interest rates
• Access to funds if you lack other qualifying assets
• Flexible use of loan proceeds for any purpose

Cons

• Risk of losing your land if you default
• Need to have substantial equity built up
• Loan eligibility still depends on credit scores
• Lenders leery of raw, undeveloped land
• Closing costs and liens complicate future sales

Steps for Getting a Loan with Land as Collateral

If you think using your land as collateral for a loan makes sense, follow these steps:

• Check your equity – Do you have adequate equity to meet lender requirements? Is your land valuable enough to secure the size of loan you need?

• Get prequalified – Most lenders will want to evaluate factors like your credit score, income, and expenses before issuing an official loan approval. The prequalification process establishes if you meet baseline requirements.

• Select a lender – Shop around with banks, credit unions, online lenders, and mortgage brokers that offer loans with land as collateral. Compare interest rates and terms.

• Formally apply – Complete the full loan application including documents like bank statements, tax returns, the land deed, and appraisal.

• Close on the loan – The lender performs final due diligence, including recording liens. You then get the loan proceeds, minus any fees.

• Make regular payments – Avoid default by carefully following the repayment schedule. Track deadlines for your monthly payments.

Using Land Collateral Loans Safely

While using land as collateral provides great access to financing, make sure you go in with full awareness of the risks:

• Only use equity that you can comfortably afford to lose in a worst-case scenario. Don’t put up land that’s deeply sentimental.

• Be very conservative and intentional with how you use the loan proceeds. Don’t borrow more than you absolutely need.

• Build some wiggle room into your budget to account for potential hiccups in your ability to repay on time.

• Thoroughly review the loan terms, foreclosure processes, and your rights in a default situation before signing anything.

• Have a backup plan to access funds for getting caught up on payments if you face unexpected financial hardship.

Taking these precautions will help ensure that venturing into lending with land as collateral goes smoothly and safely. With proper diligence, you can prudently tap into your property equity to access financing that may not otherwise be available.