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.
For many homeowners, building a custom home is a dream come true. But securing financing can be a challenge, especially coming up with the down payment. If you already own the land where you want to build, using it as collateral for a construction loan can help make your dream home a reality.
What Does It Mean to Use Land as Collateral?
Collateral is an asset that a borrower pledges to the lender in case of default. With a home construction loan, the land where the home will be built serves as the collateral.
If for some reason you can’t repay the construction loan, the lender could seize the land to recoup their losses. But providing land as collateral shows you have “skin in the game” and can help you qualify for the loan and get better rates and terms.
Benefits of Using Land for a Construction Loan
Some key benefits of pledging land as collateral include:
- Requires less cash upfront – Land equity substitutes for large down payment
- Build your dream home even with limited savings
- Indicates financial commitment to the lender
- Allows you to tap into land equity you already have
- Can help you qualify for a larger loan amount
- Improves loan terms like lower interest rate
Using the equity you’ve built up in land you already own reduces the cash you need to build a home And it shows the lender you have the means to repay the loan even if the home value drops
How Much Can You Borrow Against Land?
How much you can borrow using land as collateral varies between lenders. But in general:
- Up to 75% loan-to-value ratio – Lenders may loan up to 75% of the land’s appraised value
- Up to 80% LTV with land as collateral – Some lenders will go up to 80% LTV on the total project costs
- 100% financing with a guarantor – A family member guarantees the loan, using their assets as additional collateral
Strong finances, credit score, and relationships with local lenders may allow you to push loan-to-value ratios even higher when using land as collateral.
Steps to Getting Approved for a Construction Loan with Land
If you want to build a home on land you already own, follow these key steps:
- Find an experienced construction lender – A loan officer that knows the process is critical
- Get preapproved – Confirm you can borrow enough for the project before finalizing plans
- Understand required collateral – Know the loan-to-value ratio and your land’s appraised value
- Prove land ownership – Provide the deed with no liens or mortgages attached
- Pick a reputable builder – Lender will want to review their qualifications and finances
- Have land professionally appraised – Documentation of current market value is needed
- Submit loan application – Provide required income, credit, and financial documentation
- Anticipate closing costs – Plan for fees like appraisal, origination charges, etc.
- Lock in interest rates – Consider a fixed rate over the entire construction loan term
- Know the draw schedule – Loan funds will be distributed in phases based on project milestones
Following these steps helps ensure construction loan approval using your land as collateral for the down payment.
What is a Construction-to-Permanent Loan?
Construction-to-permanent loans, also called one-time close loans, combine the construction loan and mortgage into a single loan.
With this all-in-one option:
- Only one application and closing process
- Land collateral can finance both construction and the permanent mortgage
- Often higher rates during construction phase
- Some lenders offer fixed rates for the full term
Construction-to-permanent streamlines the borrowing process. And using land as collateral lowers barriers, especially for first-time home builders.
Alternatives to Use if You Don’t Have Land
What if you want to build but don’t already own the land? Alternatives to use instead of land as collateral include
- Save up 20% or more for a traditional down payment – Build your cash reserves before applying for a construction loan
- Explore loan programs for first-time home buyers – State and federal programs help with down payments
- Ask family members to help – A family gift or loan for your down payment avoids pledging land
- Consider owner financing with the land seller – Make payments over time to buy the land before building
- Buy the land first – Close on the land purchase, then get a building loan afterward
Coming up with the down payment is the biggest obstacle for many potential home builders. But with the right preparation and financing strategy, you can still make your home building dreams a reality.
Partnering With the Right Lender
As you explore construction loans using land as collateral, the right lender makes all the difference. Look for lenders that:
- Specialize in construction and land development loans
- Offer construction-to-permanent financing
- Have competitive rates and reasonable fees
- Are familiar with custom home builders in your area
- Allow joint construction and permanent loan applications
- Have a streamlined lending and draw process
A lender well-versed in leveraging land as collateral understands the home building process and the risks involved. That expertise translates into more options for using your land equity to finance new construction.
Is Using Land Collateral Right for You?
While pledging land as collateral has many benefits, it also comes with risk. Make sure you:
- Are committed to building and owning the home long-term
- Won’t need to borrow against the land equity later
- Understand the implications of defaulting on the loan
- Have stable income to repay the construction loan
- Won’t need to sell the land quickly if plans change
Work with a lawyer to fully understand the terms and risks involved with leveraging your land for a construction loan. But for most holders of vacant land, tapping into that equity to finance a dream home build makes good financial sense.
Turn Raw Land into Your Dream Home
For those with vacant land waiting to be used, a construction loan is the vehicle to turn it into your perfect custom home. As an alternative to a large down payment, using your land’s equity as collateral can make building a new home affordable and within reach. Partner with lenders and builders familiar with the process to ensure your home building project goes smoothly from securing financing to the final walk-through of your completed dream home.
What Does it Mean to Use Land as Collateral for a Loan?
One way to secure a collateral loan is by using any land you own, including construction loans and even personal loans, if the lender approves you. To use the land as collateral, the land must have an equity value that is equal to or exceeds that of the loan amount. You must own it outright unless it is specifically a land loan.
Once a lender approves the land as collateral, a lien will be put on the land. The lien will be released as soon as the loan is paid in full. If the loan is not paid on time or defaults, the lender can seize the land, as set forth in the contract.
To find the value of your land, the lender will typically require an appraisal from a real estate appraiser. The appraiser will assess the land value based on several factors, such as its condition, position, location, and environmental factors. For example, land further away from cities may be valued less than that near a populated area. If the land is near a city and the city has a restriction on it, such as an environmental protection act, its value would be impacted.
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.
Can I use my land as down payment for a construction loan?
Can a construction loan be used as collateral?
Using your land as collateral, a construction loan for the building project is combined with a mortgage loan for your finished home. These loans have one approval process, one closing date and one set of closing costs. You will want to shop lenders for such a loan.
Can a land equity loan be used for construction?
If you are approved for a land equity loan or line of credit, you can use these funds for whatever you like, including a down payment for the construction of your home. What is a land equity loan? A land equity loan will allow you a lump sum to spend on your construction down payment with the option of a fixed or variable interest rate.
Can land equity be used as collateral for a loan?
You may find it harder to use your land equity as collateral for a loan if you still owe money on a land loan. If you’re struggling to find a land equity loan lender that’ll serve you, look at local banks or credit unions that operate in the area where the land is located. Flexible funds.
Should I use my land as collateral?
If you purchased land solely for investment or leisure purposes and have no immediate plans for development, using your land as collateral may be a viable option. However, it’s essential to carefully assess the risks and ensure that you can comfortably afford the loan payments.