Can You Subdivide Land with a Mortgage? Essential Steps Explained

Why subdivide land? 5 benefits of subdivision

There are a few potential reasons why you might want to subdivide part of your land. Here are a few of the most common ones:

• Generate income by selling the piece of land after subdividing it. The most common reason to subdivide land is to generate additional income. A subdivision project is a way for a landowner to tap into the value of the land without selling the entire property.
• Make it easier to sell a large piece of land. It can be difficult to sell a large piece of land. By dividing the land into smaller plots, it may be possible to attract more potential buyers. Reducing the cost of the land you're selling means you'll have a bigger pool of potential buyers.
• To better utilize the land. If the landowner has a specific use in mind for the subdivided lot, subdividing the land is a way to realize this vision. For example, maybe a portion of land could be rezoned from residential to commercial, increasing the value.
• Make it easier to build another home. Maybe you want to build another home on your property – perhaps for a family member or as a rental unit for extra income. Subdividing creates a distinct legal lot for this new building. This simplifies future ownership or potential sale of just that second dwelling later on, separate from your main home.
• Dividing land amongst family. Sometimes a property owner wants to divide a piece of land amongst family members. In some jurisdictions, the family division process is shorter and less complicated than a typical subdivision.

Regardless of the reason to subdivide, it's important to understand the whole process before starting. Next, we review the steps involved in subdividing a lot with a mortgage.

Steps for subdividing property with a mortgage

The exact steps to subdivide property with a mortgage vary by location and circumstances, but there are a few general steps that apply to most situations. If you have a mortgage on the land you are looking to subdivide, there are a few additional steps you will need to take:

1. Check if the land is eligible for subdivision. You may need to research the zoning laws and other regulations that apply to the land and determine whether subdivision is allowed. You may want to consult with your city or county government, or a land surveyor or land use attorney to help you understand the regulations. For example, when land is subdivided each new parcel has to meet a minimum size.
2. Get permission from your lender. If you have a mortgage on the land, you may need to get permission from the lender to subdivide the property. Strictly speaking, it's not the subdivision of the land itself that requires lender approval. But if you want to sell or transfer the new parcel, then you will need your bank's approval. We cover this step in more detail below.
3. Develop a subdivision plan. You will need to create a detailed plan for the subdivision. The type and extent of documentation varies widely depending on the subdivision type. For a simple subdivision, having a surveyor prepare a plat of the proposed subdivision may be sufficient. In other cases, you may need to hire an engineer to detail the infrastructure or other improvements that will be made. Consult your local planning and zoning authority for the documentation requirements.
4. Get the necessary approvals and permits. You will need to obtain any necessary approvals and permits from local authorities in order to proceed with the subdivision. This may include zoning approvals, building permits, and other permits required by local ordinances. This process takes anywhere from a few weeks for the simplest subdivision, to well over a year for a complex subdivision.
5. Make any necessary improvements to the land. Depending on the requirements of the local authorities and the nature of the subdivision, you may need to make improvements to the land, such as installing infrastructure or making changes to the existing landscape. Examples of this might be extending a sewer line or creating road access for the new parcel.

Once these 5 steps are complete, you can sell or transfer the individual plots to buyers or other parties.

Why do I need my bank's approval to subdivide a property?

Before going into the steps to get approval from the mortgage holder, it's important to note why lender approval is needed to subdivide your land. Your property is collateral for the loan. If you subdivide and then sell a portion of a property, you've reduced the value of the retained property. That means you've also reduced the collateral for the bank.

How will your lender even know? Practically speaking, this will become an issue at the time of sale. If you don't obtain your lender's consent or refinance the mortgage, at the time of sale you will be required to pay off the mortgage. This is because the mortgage remains as a lien on the entire property. For the land buyer to get free and clear title, all liens need to either be paid off or released at the time of sale.

This could work in very limited situations. For example, if you're going to be selling a parcel of land for much more than the outstanding mortgage on the property. In this case, the mortgage amount would be paid off at closing and deducted from the seller's sale proceeds. For most people, however, this will not be the case and lender approval will be required.

What paperwork will your lender need?

Your lender will need official documentation to review the proposed subdivision. The exact list can vary between lenders, but expect to provide things like:

• A New Survey: This is crucial. It needs to clearly show the proposed new property lines, the dimensions of each new parcel, any easements (like for driveways or utilities), and the location of existing structures.
• The Official Subdivision Plan: This is the plan you'll likely need to submit to your local planning or zoning board for approval. Your lender will want to see exactly what the town is potentially approving.
• A New Appraisal: The lender will almost certainly require a new appraisal. This appraisal needs to determine the market value of the land and home you plan to keep after the subdivision is complete. This helps them calculate that all-important LTV ratio on the remaining collateral.
• Proof of Local Approvals: Evidence that you have applied for or received approvals from your city or county planning/zoning department for the subdivision.
• Specific Lender Forms: Some lenders, especially for conventional loans that might be sold to major investors like Fannie Mae or Freddie Mac, may have their own specific forms. For example, you might encounter Fannie Mae Form 236 (Application for Release or Partial Release), or a similar internal document the lender uses to process your request formally.

Your best bet? Call your lender directly and ask exactly what documentation they require for a partial release request related to a subdivision.

How a partial release of mortgage works

When your lender agrees to let you subdivide and potentially sell or re-mortgage a piece of the land, they perform what's called a Partial Release of Mortgage. This is a legal process where the lender agrees to remove their mortgage lien from the specific parcel being split off, while keeping the lien on the part you retain.

Here’s a typical flow, though timelines can vary widely (think weeks or even several months depending on the lender and complexity):

1. Application: You formally submit your request with all the required paperwork.
2. Review: The lender reviews the survey, appraisal, local approvals, and your loan status.
3. Appraisal Order: They'll likely order their own appraisal (which you'll usually pay for) to confirm the value of the remaining property.
4. Conditions: If they tentatively approve, they'll issue conditions. This might include paying down the mortgage balance to meet their LTV requirement, paying processing fees, or finalizing local subdivision approvals.
5. Closing: Once conditions are met, lawyers or a title company will prepare the partial release documents. These are formally signed and recorded, legally separating the subdivided parcel from your mortgage lien.

Be Prepared for Fees: Lenders often charge fees for this process. These can include:

• Appraisal fees
• Processing or administrative fees
• Legal fees for document preparation and review
• Recording fees (paid to the county)

Your mortgage type matters (FHA, VA, USDA, Conventional)

The type of mortgage you have can definitely impact the process and the rules.

• Conventional Loans: These loans, held by banks or sold to Fannie Mae/Freddie Mac, often have established procedures for partial releases, like the Form 236 mentioned above. However, specific requirements (like maximum LTV) can still vary.
• Government-Backed Loans (FHA, VA, USDA): These loans often have more specific and sometimes stricter guidelines regarding changes to the collateral property. Subdividing might be more complex or, in some situations, potentially not allowed depending on the specific program rules and when the loan originated. It's absolutely essential to check the specific guidelines for FHA, VA, or USDA loans if you have one.

Again, the rule is to check directly with your lender or loan servicer to understand the specific rules tied to your loan type.

Conventional loan requirements for subdividing

Below we provide Fannie Mae's requirements for evaluating requests to subdivide a property. Your lender's requirements may be different, but these are good guidelines for anyone to consider before getting started. That's because Freddie Mac and Fannie Mae represent the majority percentage share of all mortgage originations in the US, according to the Federal Housing Finance Agency. The full guidelines are available in the Evaluating a Request for the Release, or Partial Release, of Property Securing a Mortgage Loan publication.

To get started, you must submit a complete Application for Release of Security. The application must include the following documentation:

1. A survey, plat or aerial map depicting the original land purchased at origination and the boundaries of each distinct lot resulting from the subdivision.
2. An appraisal dated within six months of the request date indicating the value of the property prior to the subdivision and once the subdivision has occurred.
3. Subdivision application, submitted to the appropriate jurisdiction.

In addition, the following conditions must be satisfied to meet Fannie Mae's requirements to approve a subdivision request:

1. The original loan must be current. The bank will be looking to see that you're still paying the mortgage.
2. The mortgage loan must have been originated greater than 12 months prior to the date of the request.
3. The mortgage loan must not have been greater than 30 days past due more than once in the most recent 12-month period. It also may not have otherwise been in default under the terms of the mortgage loan over the most recent 12-month period.
4. The priority of the mortgage lien must not be impacted. This means no new liens will supersede the existing loan in priority.
5. Any existing structures associated with the collateral property must be located completely within the boundaries of a single lot created through the subdivision.
6. The subdivision of the property has to satisfy the subdivision laws of the county or jurisdiction and comply with all zoning regulations or codes.

Finally, the new loan-to-value of the collateral property has to be considered. The subdivision request can be approved if the new loan-to-value of the retained property is less than 60%. If not, then the request can still be approved if you as the borrower agree to reduce to the loan balance below 60% loan-to-value prior to the subdivision.

How old does your existing mortgage need to be?

Some lenders have a "seasoning" requirement. This means they want to see that your mortgage has been in place and paid on time for a certain period, often at least 12 months, before they'll consider a major request like a partial release for subdivision.

Why? Lenders get nervous if it looks like someone took out a mortgage with the immediate intention of splitting and selling off the land. They want to see a history of payments on the original property before agreeing to alter their collateral. If your mortgage is brand new, you might need to wait a bit before making your subdivision request.

Can I sell subdivided land with a mortgage?

Yes, you can sell subdivided land with a mortgage once you've followed the steps above. In fact, the most common reason to subdivide land is to sell it. However, there are a few important things to consider before doing so:

1. Make sure you have the lender's permission. If you have a mortgage on the land, you will need to obtain permission from the lender to sell part of the mortgaged land.
2. Check how much equity you have in the property. Most likely, you will either need a partial release of mortgage or refinance the property to subdivide your land. Having sufficient equity in the property is key to either one. To obtain a partial release of mortgage, you're essentially asking the lender to reduce their collateral. Having a sufficient amount of equity in the remaining property to be mortgaged will make it more likely for your lender to approve the request.
3. Be aware of the local subdivision requirements. Before reaching out to your lender, you'll want to know if subdividing is feasible. For example, there may be a minimum lot size or access requirements to meet. Share your plan to subdivide with the local planning board, or find a land surveyor or real estate attorney to help you understand the regulations.

By checking these requirements first, you can make sure a subdivision is possible and worth your time to investigate further.

Conclusion - Do you still want to subdivide your land?

Subdividing land can be a complex and costly process, so it's not right for everyone. If you have a mortgage on the property, it's one more complication to deal with. It's possible to subdivide and then sell land, but in most cases, you'll need to obtain your lender's consent or refinance the mortgage.

Depending on the value of the remaining property and amount of the mortgage, the lender may deny your request. It's important to move forward in a stepwise fashion so that you don't spend a lot of time, money, and energy on something that may not be possible.

Review all the steps and contact experts in your area before getting started. The rewards for subdividing land can be large, but the process can be difficult and time-consuming. Consider these factors to determine whether subdividing your land is the right decision for you.

Please consult your financial advisor, accountant, real estate attorney, or tax specialist. This article is for informational purposes and is not tax or legal advice.