There are lenders that accept land as collateral. You may find a land equity loan (a loan that uses land as collateral) through banks, credit unions, and online lenders.
There are many different types of collateral you can utilize for secured loans. Loans that rely on collateral can be used for a wide variety of purposes and can offer competitive interest rates compared to the common unsecured personal loan.
If you are considering using land or property as collateral, it is essential to have a proper understanding of what that might entail, both the positive and negative. Additionally, there is an abundance of loan types that use land or property collateral. By reviewing the details of each loan type, you can determine which one best suits your purposes.
How Collateral Loans or Secured Loan Options Work
A secured loan utilizes collateral to back up the money borrowed. With a secured loan, the equity value is typically equivalent to or more than the loan amount. Collateral makes a loan significantly more secure, hence their name. There is less of a risk that a lender will lose money if the borrower cannot repay the loan because they can simply claim the equity in the collateral through foreclosure or repossession.
Because of the decreased risk, borrowers can typically obtain better interest rates on loans with collateral compared to unsecured loans. Common loans that use collateral include mortgage loans, car loans, land loans, title loans, home equity loans, and land equity loans. Sometimes personal loans can also be collateral loans, depending on the borrower’s finances and the lender’s policies. Several of these can rely on either property or land as collateral.
Unsecured loans like online quick cash loans will have higher interest rates to compensate for the increased risk that comes with no collateral unless the borrower has excellent credit.
Types of Loans That Use Property As Collateral
Using property as collateral is slightly different from using land as collateral on its own. Even though property sits upon the land, there is more value added to the land since a lot of labor went into building what sits atop it.
A house and the land it is on act as collateral for both mortgage loans and home equity loans. Here is a brief overview of how each of them works:
Mortgage Loans
Residential mortgages utilize the house the borrower is purchasing as well as the land as collateral. The mortgage provides the money to buy the home while using the equity value to secure the amount borrowed.
If the homeowner stops paying the mortgage for over 120 days, the lender may begin the legal proceedings, which could lead to foreclosure and the repossession of the property. After the property has been foreclosed on, the lender can sell the house to make up the remainder of the principal of the loan.
Home Equity Loans
A home equity loan functions similarly to a mortgage, but the purpose is entirely different. A home equity loan can be used for any number of intentions rather than just to purchase a home. And there are home equity loans for bad credit. With a home equity loan, also known as a second mortgage, the homeowner uses the equity in their home to take out a line of credit.
This money can be used for construction, consolidating debt, starting a business, and many other things. The same foreclosure process of a mortgage will be followed if the borrower stops paying their home equity loan. Like a mortgage, the lender will treat both the property and land as collateral.
Types of Loans That Use Land As Collateral
You can also obtain loans by using land without housing as collateral. While these collateral loans tend to be less common, they function in a similar manner. Land loans can be used to finance a plot of land or construction on that land. It’s possible to use the equity in land you already own as collateral to borrow money.
Here is a basic overview of the various types of loans secured through land equity:
| Type of Land-Backed Loan | Description |
| Construction Loans | Short-term loans to cover construction costs for immediate home building projects; suitable if you’re ready to start construction right after purchasing land. |
| Land Loans (Lot Loans) | Suited for future home builders who need more time to plan their dream home; ideal for those with potential construction delays or detailed planning. |
| Raw Land Loans | Used to purchase undeveloped land with no utilities; requires a comprehensive development plan for approval; typically high-risk for lenders. |
| Unimproved Land Loans | Used for slightly more developed land with basic amenities but still lacks certain utilities; necessitates detailed development plans for approval. |
| Improved Land Loans | Used to purchase fully developed land with access to amenities like electricity, roads, and water; typically less risky for lenders with lower interest rates. |
| Land Equity Loans | Similar to home equity loans, uses existing land equity as collateral; versatile use but may have stricter terms and rates, especially for raw or unimproved land. |
Continue reading to learn more about these loans:
Construction Loans
A construction loan is a shorter-term loan to cover construction costs for individuals ready to start building immediately. If you are buying land and prepared to begin the construction process right away, a construction loan is probably the right option for you. Construction loans are for people who have their home building project ready to go and plan to start directly after the purchase of the land.
Land Loans
Land loans, also known as lot loans, fit better for future home builders who may need some more time to work out all the details of their dream home. If your circumstances or planning process might cause construction delays, a land loan could be the better option for you to purchase your plot of land before you begin building.
Land loans are typically divided according to what type of land is being purchased.
Raw Land
A raw land loan is used to purchase undeveloped land with no electricity, roads, or sewers. In order to qualify for a loan for undeveloped land, you will need a thorough, well-thought-out, and detailed plan on how to develop the land for building property.
Unimproved Land
An unimproved land loan is used to purchase slightly more developed land with a few amenities. Unimproved land will typically have a few of the more basic utilities but still lacks things like a phone box, a natural gas meter, and an electric meter. You will need to provide plans similar to those required for a raw land loan on how you plan to develop it because unimproved land loans are also challenging to obtain.
Improved Land
An improved land loan is used to purchase land that is fully developed and has access to amenities such as electricity, roads, and water. Improved land will likely be more expensive meaning you will need a more considerable loan amount for it. Fortunately, these land loans are less risky for lenders, so they tend to have lower interest rates and accept a smaller down payment than unimproved land.
Land Equity Loans
Similar to home equity loans, a land equity loan uses the amount of equity you already have in your land to borrow against. The money from a land equity loan can be used on any number of things, but the rates and terms might be less general with a land equity loan than with a home equity loan because land equity loans present more of a risk to the lender. Particularly, if the land equity loan is being used for land that is raw or unimproved land.
Credit unions and smaller lenders offer land equity loans. The amount you may qualify for on land equity loans will depend on the appraised value of the vacant land and how much equity you have in it. Although a land equity loan works similar to a home equity loan, you may have to do a deeper search to find a land equity loan lender.
Pros and Cons of Land Loans
Deciding whether or not to obtain a land loan will depend greatly on your determination to build the home of your dreams. If you have always wanted to build your own place on a piece of land, a land or construction loan could make that happen.
Making sure you have a solid plan and a strategy for paying off the scheduled installments every month should eliminate any risks that could come from land and construction loans.
However, it is important to understand any possible drawbacks of a land loan, so you know what to be prepared for and what you need to avoid. Since the land has no building on it, land loans pose more of a risk to lenders since vacant land is more difficult to sell than a house. Because of this, you might face a higher interest rate and down payment. The same can be said for a land equity loan. Land loans may require a down payment as high as 50%.1 Interest rates generally range from around 4% to 6% or higher based on the loan term and your specific credit risk.2
It is crucial that you also understand that not repaying your lender according to the loan terms could result in the possession and foreclosure of the land. You must be sure that you have budgeted enough to cover your construction costs and all the loan payments because, unfortunately, complications in the construction project will not sway many lenders from attempting to collect on a loan.
FAQS On Land Loans/ Using Land as Collateral
Below are answers to some commonly asked questions about land equity loans, and other land loan options that you can look into, to figure out if using land as collateral is right for you:
A land loan provides funds specifically for purchasing undeveloped or partially developed land, while a mortgage loan is used to buy a home, utilizing the property itself as collateral.
Secured loans like land loans typically offer better interest rates because they use land as collateral. In contrast, unsecured loans don’t require collateral but usually come with higher interest rates, especially if you have a low credit score.
Home equity loans allow homeowners to borrow against the equity built up in their property, whereas land equity loans permit borrowing against the value of owned land. Both loans use the respective properties as collateral but may serve different purposes.
For undeveloped plots, lenders usually offer raw land loans and unimproved land loans. Raw land loans are for completely undeveloped land, while unimproved land loans cater to land with some basic amenities but not fully serviced.
Yes, you can leverage your land equity for a construction loan, often referred to as a land equity construction loan. It allows you to use the equity in your land as part or all of the down payment for the construction.
A cash-out refinance involves replacing your current loan with a new mortgage loan for more than you owe and taking the difference in cash. In contrast, a land equity line provides a credit line based on your land’s equity, allowing you to draw funds as needed.
A land equity loan works by allowing borrowers to use the equity in their land as collateral to secure the loan, typically offering better interest rates. Personal loans, on the other hand, can be either secured or unsecured, with the latter often having higher rates if not backed by any collateral.
Yes, most lenders require a down payment for both these loans. A down payment is a percentage of the loan that you have to put down to get approval. Lenders may require a larger down payment for borrowers who don’t have the best credit or don’t meet the financial requirements. The exact amount can vary based on the loan type, property value, and borrower’s financial situation.
While it might be challenging, some lenders may offer these loans to those with a low credit score, but they might come with higher interest rates and stricter terms compared to those offered to borrowers with better credit scores. You may also have to provide a larger down payment for your land loan.
It depends on the amount of equity you have built up. If the land’s current value exceeds what you owe, some lenders might offer land equity loans or a land equity line based on the difference. However, terms might vary based on the amount of equity and the overall loan amount.
The primary risk with collateral loans such as land equity loans is the potential loss of the collateral (in this case, the land or property) if the borrower defaults on the loan. Lenders can initiate foreclosure or repossession processes to recover their money.
Key Takeaways With CreditNinja
Land loans can be much more complicated than some credit accounts like credit cards or personal loan options and so navigating the realm of loans that accept land as collateral can be intricate. But it’s an avenue that can lead to homeownership, land development, or even the realization of your dream project.
At CreditNinja, we believe in empowering our readers with knowledge and resources, ensuring you make informed decisions tailored to your needs. Whether you’re considering a land loan, a home equity loan, or even an unsecured loan, the power lies in knowing your options and the associated pros and cons.
References:
- Everything You Need to Know About Land Loans | Personal Loans and Advice | U.S. News
- Land Loans: What You Need to Know | Loanbase.com
- Land Loans: Everything You Need To Know | Rocket Mortgage
