Dear M & M: I am considering buying land and then using the land as collateral for a loan to borrow money for a building to build on next year. Is this a good idea? Doug
Dear Doug: There are countless types of collateral used to secure any loan. Remember almost anything can be used as collateral as long as it is acceptable to the lender. The reasons why any type of collateral would or would not qualify or be suitable for a loan would depend on the type of loan, bank policies, amount, and value etc. The following are some of the common types of collateral usually demanded and accepted by commercial loan lenders. Cash, Real Estate (Land and Building), Plant and Machinery, Marketable securities (Stocks and bonds, Certificate of Deposits, etc.), Crops and Livestock, Inventory, Accounts Receivable, etc. Cash is always king. However, Real Estate to include Land and Building represent one of the commonest types of collateral used. One needs to remain cautious as many times a lender will only give a percentage of the value of the land to be used towards a collateral commitment. Financial institutions take a conservative approach when valuing assets to be pledged as collateral. The reason is that they will have to spend additional resources to resell in case of default. Raw land might be hard to resell and people will have to be paid to list, find a buyer and get it in condition to sell. Banks consider the fair market value of the asset and not what the company paid for it. It is a good idea to use the services of an independent appraiser. This is important if there is a substantial difference between the bank’s appraisal and what the asset is worth in the view of the company’s management. Companies and individual borrowers can use two types of collateral – assets they’ve already pledged and assets and property they own. Financial institutions prefer property for which the borrower has a title of ownership. They accept different pieces of equipment and real estate, including second homes, motorcycles, trucks, and watercraft. Remember not all banks will consider vacant land as collateral to secure a loan in case of default. A good idea before you buy would be to have a conversation with your lender before you make the land purchase and see how they feel about using the land you are considering buying as collateral to build on down the road.