The amount of down payment needed for a farm or land loan is one of our most frequently asked questions. This article outlines factors that determine the down payment required. One of those factors is the type and quality of collateral. Collateral is a tangible asset that the applicant owns free and clear. This asset can be pledged toward the purchase as part or all of the down payment.
If the borrower fails to honor the terms of the loan by not making payments, then the collateral can serve as part of the repayment for the loan. Borrowers sign a promissory note that states they will do whatever is required to make sure their loan is repaid. This means that any and all owned assets can serve as a source of repayment if the loan goes into default, not just the identified collateral.
What is a tangible asset?
In the case of a real estate loan, additional real estate, is a tangible asset. FCS Financial will not secure a real estate loan with a vehicle. Most vehicles only depreciate from the date of purchase. In general, the value of a vehicle in 12 months is less than that vehicle’s value today. The hope is that land will at a minimum maintain its value, if not increase.
So how much do I need to put down?
Each situation is unique but most fall within two scenarios. Either a complete cash down payment or using equity in other owned real estate that is free and clear of any existing mortgage.
Example*
Claire wants to buy 40 acres of bare land for $100,000. The down payment on farmland is often around 30%, so Claire can apply for a loan for $70,000 but she will need a down payment of $30,000. Another down payment option for Claire is to use existing owned real estate instead of cash as a down payment.
Claire already owns the adjoining 15 acres valued at $2,500 an acre for a total of $37,500. Claire has $5,000 in cash to contribute to the down payment, she decides to pledge the 15 acres she owns as collateral to buy the new property. Many lenders will not loan more than 70% of the appraised value of the new property.
A lender uses a loan to security (property) value ratio to determine the amount of risk they are willing to assume. This means the lender takes the loan amount and divides it by the appraised property value plus the value of any collateral pledged. Claire’s loan amount is $95,000, so she needs at least an additional $35,700 to get the 70% loan to value of security position. By using the 15 acres she owns, she can get to the required security position with only a $5,000 cash down payment.
Loan to security value = $95,000 = 70%
$100,000 + $35,700
She decides to pledge the 15 acres she owns toward the down payment for the 40 acres. The seller will receive $5,000 in cash making the loan amount $95,000 and the lender will place a deed of trust on the fifteen acres already owned plus the purchase in order to meet the loan to security value ratio.
*This example does not include any fees that may be charged by the lender for the appraisal, title work or origination documents. Funds in addition to the down payment are needed to cover any fees assessed. A lender will be able to outline those fees in advance but be sure to ask about them.
What is a deed of trust?
A deed of trust is a recorded document where the legal title of a property is transferred to a trustee who holds the title in trust as security for the lender and borrower. The trustee holds the title until the debt is repaid to the lender. All deeds must be filed with the County Recorder. Once the debt obligation is paid, the lender issues a release of the deed of trust which says they no longer have any right to that property.
More information on collateral is provided in the video below or to learn more about the land loan application process, contact one of our local loan officers.
