Definition and Examples of Land Equity Loans
A land equity loan relies on your equity in an undeveloped lot or parcel of land. Equity is the difference between the amount owed on the land (if any) and the land’s value. The land acts as collateral; if you were to default on your land equity loan, the lender could take the land to recoup losses.
Land equity loans may be more readily available for more significant land acreage. Land may be more valued if it is used for agricultural, oil and gas, mineral rights, timber, or recreational (hunting) purposes. Land equity loans are not as common as other types of consumer property loans.
Most land lenders will have an agricultural background, with an ability to make loans on all types of land, with some reservations, said Jeramy Stephens, partner and managing broker of National Land Realty.
- Alternate names: raw land equity, land line of credit, land cash-out equity loan
For example, say you inherit 159 acres of raw, undeveloped land due to a grandparent’s death in Mississippi, but you live in Virginia. You’d like to borrow against the land’s value to buy a car. To find out if this is possible, you’d speak with a land lender who does business in Mississippi and who will assess the land and decide whether to offer you a line of credit based on the land.
How Land Equity Loans Work
A land equity loan is simply any loan using your land as collateral. Lenders send an appraiser to evaluate your property; this may be a local appraiser or someone employed by the lender.
“Most land appraisals will require a state-certified general appraiser, and the report generally requires more detail than just a standard appraisal report,” Stephens said. The American Society of Farm Managers & Rural Appraisers (ASFMRA) can be a helpful website for locating a land appraiser in a specific area.
The land’s value depends on the appraisal regarding the highest and best use of the land, and is driven by the market. “The appraisal will have to justify the property's overall value,” Stephens said, as with a residential appraisal.
The land will have additional value if there’s potential or current income from the land from agricultural leases, timberland harvest, and mineral leases, Stephens said. It may be easier to find a lender, as a result. The land’s income could boost the borrower’s financial position—for example, if the borrower is receiving income from a farmer leasing the land. “There will be a historical rent that contributes income and value to the land,” Stephens said.
The property then reflects a history of income that can be relied upon for loan repayment. But even the potential can be helpful. “Even if there is no existing income, there is potential and projection of income as long as it's a realistic and viable source,” Stephens said.
Maximum loan-to-value and the amount you can borrow varies by lender and loan amount, he said: “Most will be between 50%-75%. Most of the cash-out refinance or LOC will exceed $25,000. The primary funding sources I have experience with, the minimum cash-out loan amount would be $100,000 and a land LOC would be $250,000. There are some options for less, but the cash-out might be more specific for intended use other than just a true equity loan. Land lenders typically are better suited for larger loan amounts.”
A land equity loan may be tied to how you’re using the loan. For example, you may only be approved if you plan to improve land, such as adding barns, septic systems, or other changes that increase the land’s value.
Types of Land Equity Loans
Land equity loans typically take three forms. In all cases, the lender will require a first position on the land (collateral) for a cash-out refinance or line of credit.
In other words, if you still owe money on the land loan you used to buy the land, you won’t be able to take out a second line of credit as with a home mortgage. You’ll need to pay it off with the proceeds, so the new land equity loan is your only loan for the land.
Land Equity Cash-Out Refinance
Land equity cash-out refinance loans pulling equity from the land generally feature the following terms, according to Stephens:
- 15-30 year terms
- Adjustable or fixed rates
- Interest rates 1.5%-2.0% higher than traditional residential mortgages
Land Equity Line of Credit
Land equity lines of credit differ by lender, but may feature the following terms:
- Three- to five-year period
- Variable rate, or one-month or one-year adjustable rates
- Interest rates 1.5%-2.5% higher than residential
- Interest due monthly, quarterly, or annually; principal is due annually
Land Equity Construction Loan
Banks and credit unions may consider your equity as contributing to your down payment for a construction loan, provided you build a home on the land within a specific time period. These loans are more common because the new home becomes part of the loan’s collateral for the financial institution. However, there may be restrictions; for example, the property may need to already have services such as water, sewer, and electric.
- Generally set up for six to 12 months
- Interest-only payments possible
- Pays off the existing lot or land lien
- May only be available for primary residences
- May convert to a permanent mortgage after construction finishes
- Borrow 70%-80% of the final loan value
How To Get a Land Equity Loan
Land equity loans are more likely to be available to the average consumer through specialized lenders such as land lenders, but may also be available from credit unions or banks. “Most of these lenders can be found with a simple online search for a company that provides the service in a consumer area,” Stephens said. “Some are more local, and others do not have local offices but will lend in most areas of the country.”
Stephens said that the borrower’s credit profile has higher standards than most residential loans for a land equity loan. Lenders look for credit scores of 680 or higher, with emphasis on total debt-to-asset ratios and debt-to-income (DTI) ratios.
If the borrower is financially strong enough to meet all obligations and the financial ratios required for the loan without any income from the property, income isn’t a determining factor for loan approval, in general. Income isn’t required to make the loan, but there should be a possibility of income from the land for most land lenders’ purposes.
“A few acres from Grandma probably isn't going to qualify for a LOC, but maybe a cash-out refinance depending on the property's overall value,” Stephens said. “Most land lenders are looking to lend a larger amount with adequate collateral. On a small transaction, if the bank or credit union is not willing to lend, it falls into a gray area where no one is available to make those loans.”
However, using equity as a down payment for your construction loan may be possible with your local credit union or bank, if the institution has experience with residential construction lending.
- A land equity loan allows you to access the equity you’ve built in a parcel of land and uses the land itself as collateral.
- Land equity loans are far less common than home equity loans.
- Land equity construction loans, equity loans for usable land, and loans for larger tracts are more common.
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