The Land Equity Loan: When You Hold a Deed to Unbuilt Land

Land without any construction on it (with or without utility infrastructure) has value. That value, minus any secured debt on the land, is called land equity.

It’s possible to borrow money from equity. It’s one way to get cash without having to transfer a deed. The cash from equity could fund construction of a home on the land — or be used for other purposes. In short, a deed holder’s equity can unlock the door to life goals.

Where Do People Find Land Equity Loans?

To borrow against their land, people look to local banks or credit unions. Some niche lenders focus their businesses on land, farm, and construction loans, and are well equipped to assess the value of land in a given area.

There are also government-backed loans based on land equity value and the borrower’s plans to build on the land.

For those who intend to start a business with the land, there are opportunities for loans backed by the Small Business Administration (SBA).

In all cases, an applicant should compare the loan length, the interest rates (which can be fixed-rate or adjustable), and approval criteria.

Applicants with debt that takes big chunks out of their monthly income can struggle to get any kind of mortgage. Land equity borrowers typically need a debt-to-income (DTI) ratio of 43% or lower.

They should also ask about down payment minimums, which lenders can set at higher points than the federally allowed minimums. Most lenders will want a new appraisal. Land equity lenders issue financing based on the land’s value, and the borrower’s equity. The lender reviews the applicant’s plans for the land in order to say whether and how much to lend. When a lender approves a borrower, a closing date is set for the borrower to receive the borrowed funds.

How Does a Land Equity Loan Interact With Other Secured Debt?

Sometimes, the land owner has a mortgage that was used to buy the land originally, and later takes out a land equity loan. If so, the land equity loan is a second mortgage on the parcel.

What does that mean? A borrower who defaults on a loan taken out against the land could lose that land to the lender in a foreclosure action. But the first mortgage has lien priority. That original lender gets first dibs after a foreclosure sale. Then, the land equity loan (second mortgage) gets repaid as far as possible with remaining sale proceeds.

As you can see, the issuer of a second mortgage takes on certain risks, and the loan’s terms and rate will reflect that extra risk. Applicants could need to show a 700+ credit score, depending on the lender. 

Land equity loans can also be land equity line of credit parallel to the well-known home equity line of credit. And a land equity cash-out refinance is parallel to the cash-out refinance that many homeowners get. This lets the borrower pay off one loan with a bigger loan and access the cash difference.

What Are the Downsides of Borrowing Against Land Equity?

The obvious one is the risk of losing the collateral to the lender. If you have trouble paying off the loan, the lender could foreclose.

Especially for remote land without access or infrastructure, loans may not be very big, yet interest rates tend to be high. Closing costs and fees could be higher, too, than on a regular home loan. This is because lenders see unbuilt land as high-risk collateral.

“Improved” land carries somewhat less risk to a lender. This kind of parcel typically has utility hookups and road access. It may qualify as a less risky lot loan if it’s ready for building a home.

A lender might issue a loan for up to 85% of the borrower’s land equity, but not always. Lending for unbuilt land could be capped, say at $50K.

And in contrast to the regular home loan, the life of a land equity loan is shorter. Watch out. It could come with a balloon payment at the end.

How Do Land Equity Loans Compare With Chattel Loans That Finance the Home, Not the Land?

You might find that land equity loans, which use the land as collateral, do come with interest rates lower than unsecured loans have. Land loans can come with longer repayment periods and possibly better rates than a borrower would get with personal loans.

That said, it’s worth doing some comparison shopping when making a plan to finance land. Will the available land equity loan products be better than chattel loan options?

A chattel loan could fund the home but not be tied to the land. That would keep the land out of the lender’s hands in the event of borrower default.

And if you plan to put a manufactured home on the land, you have other choices. For example, ask a loan officer about construction loans that let a deed holder borrow against land equity to cover the installation costs for the home.

How Do Land Equity Loans Compare With Construction Loans?

Construction loans are single-purpose concepts. Land equity loans can free up funds for goals other than building a structure on the land.

There’s also a sort of hybrid to know about: the land equity construction loan. If the borrower does have construction in mind, maybe it’s not immediate. Some land loans allow the deed holder to wait years, then start construction — without needing to refinance.

Note that the Federal Housing Administration does back loans for land purchases, for households that plan to build a primary residence on the land. These loans have helpful elements, like lower credit score minimums and  only 10% down. That’s well under the down payment minimum for land equity loans set by the Federal Deposit Insurance Corporation (FDIC): 15% (for improved land) to 35% (for raw land).

There are FHA land loan products which work as construction loans that turn into regular FHA home mortgages once the home is move-in ready.

Other government-backed sources include:

• The Department of Veterans Affairs. VA land loans are created for service personnel and vets. The VA also offers construction loans for households buying land to build on.

• The Department of Agriculture. The USDA also backs land loans if the borrower plans to use the land to build a home. USDA land loans are short-term: just five years. But the USDA also offers loans for land and construction that convert into long-term home mortgages.

Check income caps and other criteria for each government agency.

As you can see, the options are varied and overlap in a number of interesting ways. So the applicant’s research would involve consulting with a loan officer who is well versed in land equity and construction loans in a given area.