Can Land Be Used as Equity in a Construction Loan?
Can Land Be Used As Equity In A Construction Loan?
For landowners looking to construct a residential or commercial property, one common question is: can land be used as equity in a construction loan? The answer is yes. A good number of lenders permit borrowers to incorporate land into the necessary equity for the loan which lowers, or in some cases, eliminates the required cash down payment. However, using land as equity is not as simple as it sounds. To begin with, there are extensive requirements to meet, particularly regarding the ownership, value of the land, and the lender’s rules.
Interpreting the Equity in Construction Loans
Equity refers to the value of an asset that an individual fully possesses. In the context of real estate, equity is computed by subtracting any pending financial obligations from the current market value of the property. To illustrate, if you possess land valued at $100,000 and have an outstanding loan of $20,000, your equity would be $80,000. Lenders take this equity into consideration when calculating the possible loan amount, they are ready to offer you for your construction work.
Is A Construction Loan Possible with Land as Equity?
Equity can be in the form of land for a construction loan, but lenders are strict on certain criteria. To begin with, the land should either be free of ownership claims or have a considerable amount of equity if there already exists a loan on it. Furthermore, lenders will evaluate the land for its appraisal value because that is what determines its market value.
To What Extent Does Land Yield Equity?
An estimation which lenders usually consider when determining the coverage of an existing loan with the available Equity’s is known as Loan to Value ratio (LTV). One can calculate it using the formula:
LTV = Loan Amount ÷ Appraised Property Value
As an example, LTV can be illustrated through the following problem; if your land is worth $100,000 and you desire a loan of $300,000, the computation would be as follows:
$300,000 ÷ ($100,000 land + $300,000 construction) = 75% LTV
Most lenders do not like LTV ratios to be over 80%, in which case the more valuable your land is, the less additional equity you need to procure.
The appraisal process is vital in establishing the worth of the land. Various factors such as the recent sale prices of comparably located properties, the condition of the land, zoning laws, as well as the presence or absence of roads and other utilities are examined by lenders. Improved land tends to have a higher value than undeveloped land. This means land with utilities, roads and proper zoning is much more valuable than the counterpart.
Types of Land with Equity
Not every parcel of land is able to qualify equally for equity lending purposes. The type as well as condition of the land determines how much equity it can provide.
Lacking roads, utilities, and zoning approval, raw land is considered to be riskier by lenders, since its development is likely to incur considerable expenses. Contrary to raw land, improved land, typically more acceptable as equity, is accessed with approved roads, utilities, and zoning.
Other than estate features, lenders incorporate the local zoning and land use restrictions too. Should the land be insufficiently zoned to commercial or residential areas, additional approvals that may slow down the loan process will be needed. Having the sales permits and zones allow the lenders to consider the equity of the land significantly higher.
How to Use Land as Equity in a Construction Loan
Unlocking a construction loan means you need to take preparatory steps in case you plan on utilizing your land as equity.
The first step is to check whether your ownership of the land is undisputed; otherwise, lenders will not take land with title problems or clashes over ownership. In the presence of an existing loan for the land, the lender will determine what portion of the equity the borrower holds by checking the outstanding balance.
You will also need to get the land appraised. In order to obtain a loan, the lender will need to know how much money they can provide the borrower along with valuing the land, so it’s mandatory to have the land appraised officially by a professional.
Also, you will need to check what the zoning parameters are along with permits. This may be especially important if additional approvals must be granted before the ability to use the land as equity is permitted. Remember to include documentation as well which are the tax files, land deed, and any loan statements out there that are available. These documents aid in making the application process smooth and swift.
Advantages of Employing Land as Equity for Loan Equity
An important benefit of using land as equity is reduced cash down payment requirement. This is advantageous to a landowner who has no cash on hand. Equity in land allows borrowers to fulfill the lender’s requirements without using savings.
Equity in land also increases the capacity to borrow, which is called borrowing power. The more equity that you put in the loan, the better the loan terms that can be obtained, such as lower interest rates or greater chances of approval. Higher equity borrowers are viewed as lower risk, which makes lenders more willing to grant favorable loan terms.
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Equity Challenges
Despite the benefits, there are some challenges that need to be addressed. One already mentioned concern is the undervaluation of land. If the appraisal returns your land’s value much lower than expected, you may be required to provide extra cash or Equity. This is frustrating for borrowers expecting to meet their equity requirements using only land and no cash.
Is land equity permitted on a construction loan? Yes, but it is a lengthy process needing detailed planning and lender consent. For landowners, it is a powerful asset to have to help with lowering cash deposits and increasing the loan amount. The only issue is the land has to be correctly appraised, appropriately zoned, and not under serious disputes of ownership.
