Property Loans vs Mortgages: Key Differences You Need To Know

When it comes to financing real estate, two of the most common options are property loans and mortgages. While they share some similarities, there are important distinctions between these two types of loans. Understanding the key differences can help you determine which route may be better suited for your real estate goals.

What is a Property Loan?

A property loan also known as a land loan is a type of financing used to purchase vacant land or other real estate without existing buildings. The property itself serves as collateral for the loan.

Property loans allow buyers to purchase land they intend to develop in the future, whether that entails building a home, starting a business, farming, or other uses These loans may also be used by land developers or investors looking to acquire multiple vacant lots or acreage for larger projects.

Some key features of property loans:

• Used for purchasing raw, undeveloped land
• Property serves as collateral
• Typically have higher interest rates than mortgages
• Shorter repayment terms, often 5-10 years
• Require substantial down payments, at least 20-30%

Property loans provide financing for land acquisition, but construction costs would require separate financing.

What is a Mortgage?

A mortgage is a loan used to purchase or refinance developed residential or commercial real estate that includes buildings. The property serves as collateral for the debt.

Mortgages allow buyers to finance real estate purchases over an extended timeframe, typically 15 or 30 years. The borrower makes monthly payments consisting of principal, interest, and other costs like property taxes and insurance.

Here are some key features of mortgages:

• Used to purchase or refinance existing buildings
• Property serves as collateral
• Typically have lower interest rates than other types of loans
• Long repayment terms, often 15 or 30 years
• Lower down payments required, as little as 3-5%

In addition to financing the purchase, mortgages also incorporate the costs of insuring and maintaining the property over time.

Key Differences Between Property Loans and Mortgages

While property loans and mortgages have some similarities in using real estate as collateral, there are several important distinctions between these two financing options:

Intended Use

• Property loans finance the purchase of vacant land before any development.

• Mortgages finance existing structures and buildings.

Collateral

• For property loans, the raw land itself is the only collateral.

• With mortgages, the land plus any existing structures can serve as collateral. This lowers risk compared to raw land.

Loan Amounts

• Property loans tend to be for lower amounts given the higher risk. Loan amounts are based on the appraised value of the vacant land.

• Mortgages finance higher loan amounts because the property’s structures add tangible value.

Down Payments

• Property loans typically require down payments of 20-30% or more of the purchase price due to the higher risk.

• Mortgages allow lower down payments, with many lenders accepting 3-5% down. Structures on the property reduce risk compared to vacant land.

Interest Rates

• Property loans have higher interest rates, often 1-3% higher than mortgage rates. The lack of existing structures increases the lender’s risk.

• Mortgages qualify for lower interest rates due to the lower risk with developed property as collateral. This makes borrowing costs more affordable.

Loan Terms

• Property loans tend to have much shorter repayment terms of 5-10 years. Some lenders may offer terms up to 15 years.

• Mortgages offer substantially longer terms of 15 or 30 years. This provides lower monthly payments by spreading repayment over more time.

Use of Funds

• With property loans, funds can only be used to acquire vacant land. Additional construction financing is required.

• Mortgages provide combined financing for purchasing existing property and maintaining it over time, including insurance, taxes, and repairs.

Prepayment Penalties

• Property loans often charge prepayment penalties if you pay off the loan early.

• Most mortgages do not have prepayment penalties, allowing you to pay off the balance early without added fees.

When to Use Each Type of Loan

Given the key differences, here are some general guidelines on when to consider a property loan or mortgage:

Property Loans

Property loans tend to work best when:

• You want to purchase vacant land or lots for future development. This allows time to create development plans.

• You are an investor or developer acquiring multiple land parcels for larger projects.

• You don’t require immediate financing for construction and can wait to develop plans.

• You can afford the larger down payment and higher interest rate.

Mortgages

Mortgages tend to be the better option when:

• You are purchasing or refinancing an existing home or other developed real estate.

• You want to lock in low fixed rates and longer repayment terms.

• You need combined financing for purchasing and maintaining the property long-term.

• You want lower monthly payments with a smaller down payment.

• You may sell the property before the loan is paid off and want to avoid prepayment penalties.

How to Get Started

If you are exploring financing options for purchasing real estate, here are some tips on getting started:

• Consult with a loan officer or mortgage broker who can explain the options and help determine if a property loan or mortgage is better aligned with your goals and financial capabilities.

• Check your credit score and report in advance. Good credit will help qualify for the best rates and terms.

• Calculate your budget to understand how much you can afford in down payment, monthly payments, and other costs.

• Research interest rates being offered by multiple lenders and compare loan estimates.

• Read loan disclosures carefully to understand key terms like loan amount, interest rate, down payment, fees, repayment timeline, and any prepayment penalties.

• Consider consulting a real estate attorney to review loan documents and protect your interests before signing.

Taking time to understand the differences between property loans and mortgages will empower you to make an informed financing decision for your real estate goals. Partnering with an experienced lender and advisor can also provide guidance in navigating the loan process.