What Is a Land Equity Loan?
Similar to home equity, land equity is the value of your land minus any money you owe on the loan used to purchase it. With a land equity loan, you can turn that equity into cash without having to sell the land itself. You can use it to build a home on the property, pay down high-interest debt or cover unexpected medical bills.
What defines a land equity loan?
Land equity loans are similar to home equity loans, except your land is used as collateral instead of your house. The land may be raw without any improvements, or it may have some infrastructure in place, like electric and water lines. A person taking out a land equity loan may own the land outright or have a land loan, which is like a mortgage for a piece of land.
Is lot equity the same as land equity?
Land equity is sometimes called “lot equity.” However, “lot” may also be used in reference to a piece of land that has been improved and is ready to be built upon versus untouched land, so make sure you’re on the same page as your lender and contractors.
How does a land equity loan work?
With a land equity loan, you’re cashing out some of your equity by putting up your land as collateral. If you default on the loan, you could lose the land to foreclosure.
Land loans are risky for lenders — especially if you’re still paying off the land — so the requirements are typically more stringent than they are for home equity loans. Lenders typically want to see lower loan-to-value (LTV) ratios and often offer shorter repayment terms. They also tend to charge higher interest rates.
If you still have an outstanding balance on the loan you used to buy the land, the land equity loan will be a second mortgage. That means that if the land goes into foreclosure, your original loan would be paid off first, and the land equity loan will be repaid with whatever’s leftover from the sale of the property.
Types of land equity loans
There are three different types of land equity loans, and each works differently:
- Land equity line of credit. Like a home equity line of credit (HELOC), this type of loan allows you to access credit on an as-needed basis and only pay interest on what you borrow.
- Land equity cash-out refinance. You’ll take out a new loan that’s larger than your current loan balance. You’ll pay off the original loan, then pocket the difference. You could potentially lower your payments, lock in a lower interest rate and use the extra cash to improve your land or pay off other debts.
- Land equity construction loan. If you’re planning to build a house on the land, some lenders will accept your equity as part or all of a down payment on a construction or manufactured home loan.
What if you still owe money on the loan you used to buy the land?
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.
Land equity loans vs. home equity loans
| Land equity loans | Home equity loans | |
|---|---|---|
| Collateral type | Land only | Home and land |
| Loan terms |
| Up to 30 years |
| Equity needed | 65% to 85% LTV or less | Up to 100% LTV |
| Types of lenders offering loans | Credit unions and niche lenders | National lenders |
Pros and cons of a land equity loan
| Pros | Cons |
|---|---|
Flexible funds. You can use the funds for any purpose. Interest options. You can choose a fixed- or adjustable-rate loan. Longer loan term options. You can find a longer repayment period than a personal loan offers. Competitive rates. You can access interest rates lower than unsecured loans offer. | Must be secured. You have to put land up as collateral, which means you could lose the land if you default. Requires equity. Your lender may require you to have a significant amount of equity. Funds may be limited. You’ll have less buying power if the land doesn’t have essential infrastructure like water, electricity, or roads. Higher rates. You’ll have to pay more in interest than you would for a loan secured by a home. |
Land equity loan requirements
Available equity
The exact amount of equity you need varies by lender. The maximum LTV ratio is typically between 65% to 85%, depending on the type of land and the intended use of the funds. That means you’d need to maintain between 15% and 35% equity.
DTI ratio
Lenders use your debt-to-income (DTI) ratio to evaluate what you can afford to borrow. Each lender will set its own limits, but you can expect that most will cap your DTI ratio at 43% or less.
Credit score
Lenders can also set their own credit score minimums, but if you’ve got a credit score under 620, you may struggle to find funding.
Repayment terms
Land equity loans tend to have shorter loan terms, but they vary significantly by lender. Typically, loan terms are about 10 to 12 years.
Loan amounts
Some lenders may have a maximum loan amount, like $50,000. Others may not have a maximum loan amount as long as you’re at or below the maximum LTV ratio. Still, keep in mind that lenders typically lend less for vacant land, like a parcel in the woods with nothing on it, than land that has been slightly developed or has some infrastructure.
Is using land as collateral for a loan a good idea?
Overall, a land equity loan is likely best for those who:
- Have significant equity in their land
- Are certain they can afford the payments
- Have no plans to build on the land any time soon
If you have no plans to build on the land
It could make sense to tap your home equity for a goal that improves your financial position, like paying down high-interest debt — but only as long as you’re confident you can keep up with the additional loan payment.
However, if you don’t have a rock-solid plan for paying off the new loan and you’re replacing short-term debt (like credit card debt) with long-term debt, you may actually be digging yourself into a deeper financial hole. Using equity to pay off high-interest debt (like credit card debt) could just extend the agony and put your land at risk in the process.
If you’re planning to build or place a home on the land
If you have real, near-term plans to build on the land, it’s probably best not to take out a land equity loan. Here’s why:
→ You could limit your ability to get a construction loan later. If you finance the down payment for a construction loan with your equity, once the construction is finished your home would be eligible for a traditional mortgage. But that isn’t possible if you tie up your equity in a land equity loan. In that case, you may have to come up with a cash down payment for your construction loan if one is required. A land equity loan will also count against your DTI ratio, which is an important factor in qualifying for a construction loan.
→ You could unnecessarily put both the land and a home at risk. If you plan to place a manufactured home on the land and use your land equity in lieu of a down payment, you may want to think carefully about your other options. Be sure to compare using a land equity loan to any available chattel loan options, which would allow you to finance only the home. Otherwise, you could lose both your land and home in the event of loan default.
Equity is typically expressed as a percentage of the value of the land, not measured per acre. To calculate how much equity you have, subtract the amount you owe on any loans secured by the land from the appraised value of the land.
Yes. When you use land equity “in lieu” (instead) of cash to make the down payment on a loan, it’s called “land in lieu” financing. This type of arrangement is typically associated with borrowers who want to finance a manufactured home or the construction of a home on land they already own. But keep in mind that if the loan goes into default, you will lose both the home and land because you’ve now tied both to the debt.
Yes. If you own the land outright, you have 100% equity and can still borrow against that equity with a land equity loan. The amount you’re allowed to borrow will be based on the land’s appraised value, rather than a percentage of that value, as it would be if you held less than 100% equity.