Can You Use a Home Equity Loan to Buy Land?

Home equity loans allow homeowners to access the financial value built up in their property. These loans enable individuals to borrow against their home’s equity, providing a lump sum or a line of credit. The funds can be used for various purposes, from home improvements to debt consolidation.

Understanding Home Equity Loans

A home equity loan allows homeowners to borrow a fixed amount of money against the equity they have accumulated in their property. Equity represents the difference between the home’s current market value and the outstanding balance of any mortgages or liens against it. Lenders typically allow borrowing up to a certain percentage of this equity, often expressed as a loan-to-value (LTV) ratio, which combines the existing mortgage and the new loan. For example, a lender might permit a combined LTV of 80% to 90%.

The funds from a home equity loan are disbursed as a single lump sum at closing. This type of loan usually features a fixed interest rate, meaning the monthly principal and interest payments remain constant throughout the loan’s term. Loan terms commonly range from 5 to 30 years, providing predictable repayment schedules. The fixed rate offers stability, protecting borrowers from potential increases in interest rates over time.

In contrast, a home equity line of credit (HELOC) operates more like a credit card, providing a revolving line of credit up to an approved limit. Borrowers can draw funds as needed during a specific draw period, typically 10 years, paying interest only on the amount borrowed. After the draw period, a repayment period begins, requiring principal and interest payments. HELOCs often come with variable interest rates, meaning payments can fluctuate based on market conditions.

Qualifying for a Home Equity Loan

To qualify for a home equity loan, lenders assess a borrower’s ability to repay. A strong credit score is generally expected, often requiring a FICO score of 620 or higher, with some lenders preferring scores above 680 or 700. The debt-to-income (DTI) ratio is another important metric, calculated by dividing total monthly debt payments by gross monthly income. Lenders typically look for a DTI ratio below 43%, though some may approve up to 50%.

Borrowers must demonstrate a stable income source, which can be verified through pay stubs, W-2 forms, or tax returns. This income stability assures the lender that the borrower has the capacity to make regular payments. The amount of equity in the home is a primary consideration, as the loan is secured by the property. Lenders generally require a minimum of 15% to 20% of the home’s value to be eligible for a loan.

The type of property securing the loan also plays a role. Most lenders prefer to issue home equity loans against a primary residence, which is the home where the borrower lives for the majority of the year. While some lenders may consider second homes or investment properties, the terms might be less favorable. The property must also undergo an appraisal to confirm its current market value, which directly impacts the available equity and the loan amount.

Applying Home Equity Funds to Land Purchase

Funds obtained through a home equity loan can be used for various personal financial needs, including the purchase of land. Once approved and closed, the lump sum is disbursed directly to the borrower, who then uses these funds to finance the acquisition of a land parcel.

When a home equity loan is applied to land acquisition, the lender’s primary security remains the borrower’s existing home, not the land being purchased. The appraisal process for the home equity loan focuses solely on the value of the home collateralizing the loan. The raw, undeveloped land being acquired does not serve as collateral for the home equity loan itself; the home’s equity drives the loan amount.

Purchasing raw land often requires additional financing or out-of-pocket expenses for development, such as utility connections, surveys, and permitting. While the home equity loan provides initial capital for the land purchase, it does not typically cover these subsequent development costs. The borrower must ensure they have sufficient funds for these additional expenditures beyond the land acquisition cost.

The Home Equity Loan Application Journey

The application process begins with gathering necessary financial documents. These typically include recent pay stubs, W-2 forms or tax returns, bank statements, and current mortgage statements. These documents help the lender verify income, assets, and existing debts.

Upon submission of the application, the lender initiates the underwriting process. Underwriting involves a thorough review of the borrower’s financial profile, including credit history, income stability, and debt obligations. During this phase, the lender will also order an appraisal of the property that will secure the loan to confirm its current market value.

If the application is approved, the borrower proceeds to the closing phase. At closing, all loan documents are signed, and any associated fees, such as origination fees, appraisal fees, or title search fees, are finalized. These closing costs typically range from 2% to 5% of the loan amount. Once documents are signed and conditions met, the loan funds are disbursed to the borrower.