The debt-to-asset ratio is commonly used by land lenders to determine a consumer’s buying power for a vacant land loan. This leverage ratio is a way for lenders to calculate the percentage of your assets that are financed by your debts. When a ratio is higher, this indicates more financial risk. Let’s explore the lending process for vacant land.
The Debt to Asset ratio
The debt-to-asset ratio can show a lender how much of your assets are leveraged by your debts, the ability you have to repay your debts, and the risk associated with lending money to you. Land lenders primarily look at debt-to-asset ratios while residential lenders usually look at debt-to-income. This means that you could easily be approved for a home; however, a land lender might turn you down for a vacant land loan because it is considered a risker loan.
Why is land considered a risky loan?
Some traditional lenders consider land to be a risker loan because they do not understand the resale value. With a smaller market for land, and no home to see or touch, traditional banks get worried that they will not be able to sale the property as quickly if a buyer were to default. Additionally, if a buyer is hit by financial hardships, they are much more likely to default on a piece of land than they are on their home. Therefore, many traditional banks will not lend for raw land properties.
While interest rates for land will vary based on available lenders, often you will find that loans for land are 1%-1.5% higher than current home mortgage rates. In addition to higher interest rates, you may also find that land loans require higher down payments as well. On the bright side, land lenders know the product and have specialized experience in land. This experience will often make the closing go more smoothly while allowing for less delays and surprises.
How to calculate debt to asset ratio
When preparing to apply for a loan make a list of all your debts and assets. Assets refer to all properties, possessions, bank account totals, businesses, automobiles, equipment, investments, and other items that have an associated cash value. Debts refer to short-term and long-term payments that you are making. These can include home loans, student loans, automobile payments, medical bills, credit card totals, and personal loan.
Your debt-to-asset ratio will be calculated as your total liabilities divided by your total assets. A high ratio is considered to be .60 or higher, which makes it much more difficult to borrow money. You will want to determine your debt-to-asset ratio before, and after, adding in the debt from a new property. Try this formula to determine your debt-to-asset ratio before a loan.
For example, if you have assets of $250,000 and liabilities of $100,000, your before-loan debt-to-asset ratio would be .40. To calculate your after-loan ratio let’s assume you want to borrow $120,000 on a property with a contract price of $160,000 and $40,000 in down payment. Using the above formula your after-loan debt-to-asset ratio would be .59.
How to improve your buying power
The best way to improve your debt-to-asset ratio is to pay off debt. There are several ways to tackle this. Using the debt avalanche method, you’ll be able to pay less interest and get out of debt faster than other potential methods. Other methods of paying off debt include the snowball method, balance transfers, and personal loans. It is important to find the method that is right for your situation.
If you’re ready to learn more about purchasing land in your area, contact your local National Land Realty Land Professional today!