Equity, loans ... making my head spin.

Here’s my situation: I have a piece of buildable property that has appreciated since I bought it. I paid cash for it, I own it outright. It’s now worth around $100,000. I’m planning on building a new home there, and the cost of doing so will be around $220,000. How does the value of the land figure into the cost of my construction loan/30 yr mortgage? How does that equity help me out, exactly?

Since you own it outright, equity means it’s full current appraised value.

You might be able to use the value of the land as security for a loan and start building. Once the house is weathertight you can then get a conventional mortgage for enough to finish the house. In some cases, for example, only underlayment (roofing felt, AKA tarpaper) on the roof would be sufficiently weathertight to secure a mortgage, thus you should be able to get to that point for much less than half the value of the finished home.

Untill the house is weathertight, few lenders will consider it worthy of a decent loan. (Interest will be very high due to the risk of distruction by even a modest storm) When contractors build a house on speculation, thier ass is hanging in the breeze up to that point.

I see. So the value of the land acts as collateral on the construction loan. Then, I roll the borrowed sum of the loan over into a 30-yr mortgage. But the land value doesn’t help defray the costs of my mortgage in the slightest.

Depends on what the appraised value of the home + land is when the house is complete. If the land is worth $100K and the house cost $220K to build, would you be able to sell the whole thing for $320K? Probably not since nobody buys a house and the land it sits on for two seperate prices. Its usually assumed when you buy a home that the land comes with it.

I guess this could vary by region, but the answers above don’t reflect my experience. Construction loans are just that: loans based on the expected value of a home when finished. The bank will have oversight of the plans and work, and isn’t going to disperse money to the contractors until the work is done to it’s satisfaction. Interest rates are slightly higher to compensate for this slight additional risk.

Also, land and property are indeed assessed separately by the county, and will both factor into the appraised value of the property as a whole. The bank will look at comparable sales of similar homes in the area to determine a fair market value for the finished home, and that in turn determines how much they’re willing to lend you.

Your equity in the land will be rolled into the loan.

So … you’re saying that, given my 100K land equity and 220K construction loan, I’ll essentially only owe 120K on my total mortage when I finish construction?

No, you’ll get a loan for 75% of the expected value of that home once it’s completed. In this case, I would guess 75% of $320,000 ($240,000). Contruction loans usually include the purchace of the land, but since you already own it, that extra money will go to you. What I’m unsure of is whether the bank will let you get this loan only using the equity in the land as your contribution (the 25% from your end). Otherwise, you’d need to either come up with around $60,000 or find someone to give you a mortgage on your empty lot (which I’ve heard isn’t so easy).

Also, the house might be worth more than $320,000 once completed. I’ve heard that a completed house is worth up to 1.5 times as much as the costs involved in building it (land+materials+labor+permits). Ask a real estate agent what the market is for the house you plan to build in it’s proposed location.

Your equity in something is what proportion of its worth you personally own. If, for example, I own 20% of a business with a net value of $10 million, I have a $2 million equity in it. If you owe $50,000 on a mortgage on a $200,000 house, you have an equity of $150,000 in that house.

You own a buildable lot worth $100,000. You want to build a house that will cost, say, $150,000 to build – and the value of your property with house would then be. let’s say, $270,000 – that being what an appraiser would say that the lot developed with the house you propose to build would be worth in the present market.

You want to borrow $150,000 from the bank, in a builder mortgage. The bank wants collateral for its money – they are not interested in putting up 100% of the money needed to produce the result.

So you put up the land as your down payment, and mortgage house and land for the $150,000 you need to build. You give the bank a mortgage on house and land; in return, they give you the $150,000 you need to build the house. Net result: you own a parcel with a house which is together worth $270,000. You have a $120,000 equity in it, since the bank has a $150,000 claim against it. As you pay off the mortgage, your equity grows and its claim shrinks. (Remember that it gets interest on its money from you, so it’s not a one-on-one formula – but they’ll provide you with information showing how much you’re paying towards interest, and how much towards principal, reducing your loan and increasing your equity, with each payment.)

Just thought of something else pertinent here. Contrary to most people’s casual use of the terms, a mortgage is not a loan, but the exact opposite: it’s the collateralization of a loan. You give a mortgage to get a loan. The bank says, “If we give you this money, what protects our investment?” And you say, “No problemo; I’ll give you paperwork that allows you to start legal proceedings to take my property if I default on the loan.” You’re the mortgagor and the borrower; the bank is the mortgagee and the lender.