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 Works
A secured loan utilizes collateral to back up the money borrowed. 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. Several of these rely on either property or land as collateral.
Unsecured loans like online fast 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:
Residential mortgages utilize the house the borrower is purchasing 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. 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, consolidate 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.
Types of Loans That Use Land As Collateral
You can also obtain loans by using land without housing as collateral. While these 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:
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. Constructions 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, 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.
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 will develop the land for building property.
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.
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.
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. This money can be used on any number of things, but the rates and terms might be less general than with a home equity loan because land equity loans present more of a risk to the lender, particularly if that land 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.
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.
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.