How to Use Land as Collateral for a Home Loan Downpayment

How to Use Land as Collateral for a Home Loan Downpayment
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Things You'll Need

  • Deed to your land

  • Appraisal (if available)

  • Cost breakdown from builder

  • Cost estimate of closing your loan

  • Survey of land if available

  • Proof of income, paystubs and W2s (if applicable)

  • Proof of funds in bank (if applicable)

Warning

Lender guidelines as to credit for land value is sometimes restricted. If you purchased the land within the past 12 months, they will consider what you paid for it (actual verbiage says "the lesser of purchase amount or appraised value"). After 12 months of ownership, the appraised value is used.

If a relative is gifting you land surveyed from a larger tract, there can be no liens against the entire tract before they can legally gift this land to you. An exception would be where the lien holder is willing to do a "partial release" of the small tract being gifted to you.

Tip

If someone is gifting you land for your home from a larger tract of land, have a survey done on the parcel being cut from the bigger piece of land. Once there is a legal description from the survey, have a deed prepared with the owner conveying ownership to you. It is best to have a title company or attorney handle this for you so that he can check the title for "clouds." There is a charge for this work, but it is better to be safe when it comes to these types of legal matters.

Seek a construction to perm loan if at all possible. This construction loan has a feature that allows you to modify your construction loan into a permanent loan at the end of the project. This feature saves the cost of an entire closing. Most construction to perm loans do not require that you requalify for the perm at the end of the project.

Land value, or equity in land, can be used as the equivalent of cash for a down payment when building a home. To know if you have enough equity in your land to build a home with little or no additional out of pocket cost, generate a list of potential building expenses and closing costs. Then, get an appraisal on the value of your land and present this information to your home loan officer. They will then tell you whether or not you are able to use your land as collateral for a home loan downpayment. Here are tips to navigate through this complex process.

Step 1

Schedule an appointment with a lender. You should choose a company that specializes in new construction lending for your prequalification. The first meeting will be to discuss your construction plans, credit history, the types of loans available and what kind of loan you can really afford. The lender can provide you with the costs involved to close a Construction to Perm loan, giving credit for your land equity. If a previous appraisal has been conducted already, you can submit it once you choose a lender. However, there will likely need to be a more recent one completed for the purposes of this loan.

Step 2

Contract with a reputable builder. To start, schedule a time for him to view the land and discuss your plans. A reputable building contractor will need to see the land before they can tell you what is and is not possible. Once you have gone over what you are looking for in detail, have him draw you up a cost estimate on what it will take to build your home.

Step 3

Calculate total building and closing costs. Add this amount to the value of the land. The grand total represents the cost to produce your project. The value of the land is then used as a credit against the total cost. If you owe a balance on the land, total all of the costs and add the balance of the land payoff. Depending on the bank's percentage for the construction loan, you may still have to come up with some form of a monetary down payment.

Step 4

View an example to be sure you understand the process. Let's say your cost to build is $220,000 and the land is valued at $63,000. You may have closing costs that total $15,000, depending on your state taxes and costs, so the total value of the cost to produce this project is $298,000. When you subtract the credit for the land, your new loan will be $235,000, and this is just about 80% of the cost to produce the project. You would not incur private mortgage insurance on a conventional loan, and no substantial costs to pay. There are formulas that are used by various lenders to compute loan percentages, some allow for a 5% variance in "holdback" just in case material costs increase or to account for unknown variable; however, this is the basic formula for how this process works. If there is still a lien on the land, you can still use the equity as a credit, and the balance will be paid off when you close your construction loan.

Step 5

Make a final decision based on what you can afford. If the bank will only loan 90% of the costs, and the equity in the land represents less than 10%, you will have to generate additional funds. Example: $220,000 cost to build, land value $63,000, closing cost add up to $15,000, but you owe $47,000,000 on the land. The cost to produce the project is still $298,000, but your land credit is now $16,000. ($63,000 minus $47,000). The 10% represents $29,800 required down payment, so the difference would be $13,800 of out of pocket cost to you. Only you know what you can truly afford, but remember, once the building process has begun, it is very difficult to back out. So be sure you make an informed, sound decision before hiring a contractor to build your dream home. .

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