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I own a half acre in a very convenient and lucrative area and have for years now. I still owe on my mortgage and my home is in good condition. My family is quickly outgrowing it. The home builders making the new neighborhoods in our area totally screw you so I won't be doing that. I want to build a home in my back yard WHILE living in my current home then demolish the current home. How would I get a loan for that? I have been in construction commercial and industrial and a little residential for 15 years so I'm not concerned about the know how, and a close friend would be my "general contractor"

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    I have proposed an edit whose main purpose is to change "demo" to "demolish". I initially read it as "demonstrate". I have also done a bit of copy-editing here and there to improve the flow. Feel free to reject my changes, but I really think "demo" to "demolish" is important. – Martin Bonner supports Monica Dec 11 '19 at 11:44
  • Comment because it has nothing to do with the loan: I had looked into doing something similar, the differences for us were somewhat smaller lot, and we would have built the new house in front of the old one (old one is very far back in the lot) What ultimately got me to abandon the idea was that to be approved we'd have to arrange everything so the old house was still fully accessible by fire crews/paramedics etc every step until demolition, and the lot was too narrow to reasonably do this without also tearing down additional trees and the garage I wanted to keep. – Mr.Mindor Dec 11 '19 at 15:46
  • You go to the bank, tell them your plan and how much money you need? This is not an uncommon process. Where is the difficulty? – Philipp Dec 11 '19 at 16:33
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Honestly, if your current home is in good shape, you'd be better off, financially-speaking, not demolishing it.

Your options, as I see it:

Build an extension on your house. This should be significantly cheaper/faster, and this is a common enough thing to do that you shouldn't have trouble getting a loan.

Build the new house, move over, then either sell or rent your old house. The benefit here is that you can get a lot of money this way, though you do lose access to what would be your front yard.

Build the new house on a different lot, then sell or rent your old house. This costs a bit more up front, but you should get that back once you sell/rent your old place, because it should be a bit more valuable due to the extra land. (This also gives you the opportunity to re-evaluate your current location, and move to a more convenient location if you want.) Building a house on a lot is also a common thing to do, and you shouldn't have trouble finding a loan.

In general, though, demolishing a perfectly-fine house is not a financially-sound decision.

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    Your 2nd & 3rd options assume the land is zoned for multiple residences, which it may not be. – Grade 'Eh' Bacon Dec 11 '19 at 14:08
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    "demolishing a perfectly-fine house is not a financially-sound decision" maybe not in general, but it's a common sight in some hot urban areas. I remember running through a park in suburban Houston where half of the houses were old small ranch homes, 40% were new multi-story homes and the rest were demolished (transforming the former to the latter). – D Stanley Dec 11 '19 at 14:49
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    As an example, if I can buy a lot with an old house on it for $0.5 Million, spend 10,000 on demolition, build a house for $2 Million and sell it for $3 Million that's a pretty good return. – D Stanley Dec 11 '19 at 14:56
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    @DStanley Isnt that exactly why he says 'In general' ? – GamerGypps Dec 11 '19 at 15:07
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    @GamerGypps fair enough, but the first sentence is more of an absolute, which seemed to frame the answer that way to me. – D Stanley Dec 11 '19 at 15:11
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Your literal question is,

How would I get a loan for that?

Ultimately, you'd have to talk to lenders in your area to answer that. I've never heard of a construction loan to cover the exact scenario you're describing (without some additional factors, like subdividing the lot first, or demo'ing the old house first), but that doesn't mean it doesn't exist.

That said, I can see some obstacles:

  • Zoning and setback requirements may make it really hard to site a second home on the parcel, depending on where your current home is. A half acre isn't gigantic and you may find there literally isn't a spot where another structure could go, unless the current home is shoved all the way into one corner and you're going to build all the way in the other corner.
  • Your local zoning may not even allow a second (large enough to live in) structure on one parcel. Many local governments don't like multiple independent single family homes on one residential tax parcel because the property basically becomes un-marketable (how many people, when shopping for a primary dwelling, want to buy two houses at once? Not many).
  • Subdividing would avoid issues with not being zoned for multiple dwellings, but it may be difficult depending on the site layout - for instance, if you don't have enough road frontage for both homes to have their own driveway, etc.
  • You'd have to arrange for water, power, and sewer for the second home. If you're on septic or a well, then see bullet #1 (it's even less likely you'll have space to site the second home if you've also got to find space for a second well or second septic).
  • A lender won't want to leave your current mortgage intact, since that would mean there is no way for them to get a first position lien on the new construction (again, unless you subdivide). If you have enough equity, you could consider doing the construction on a home equity loan on the first house, but that leaves you with a problem once you're ready to tear down the first house (doing so would be destroying the collateral on your existing mortgage and on the HE loan).

Depending on the equity you have in the existing home, this may be a show stopper: a lender isn't going to want to lend in a way that causes them to have a larger outstanding balance than the property is worth at any point during the project (or after it). You need a loan big enough to pay off your current mortgage but also to finance the construction. So, basically you need two houses worth of mortgage, but you will end up with only one house. How does a bank assess the value in order to determine LTV? They can't assess based on any scheme where both structures' values are included in the appraisal, if you're going to knock the old one down (because then you'd likely be upside-down after the first house was removed). They can't assess based on only one house, unless you have a ton of equity, because then you wouldn't have enough cash to finance the construction after paying off the original mortgage.

Ultimately, the most straightforward solution is probably to subdivide, and build the new house on the new parcel following typical construction loan processes (as if it was any random parcel but just happened to be right next to your current house). This lets you treat the new home and the old home separately from a lending perspective, which makes everything nice and clean. Just be aware that you'll have to be able to pay off the mortgage on the first house before you can (legitimately) tear it down, otherwise the bank will likely be able to accelerate the mortgage (basically, put you on the hook for immediately paying the entire balance). So, before talking to lenders, you may want to talk to your municipality's zoning or planning department.

Also , as a footnote, it sounds like you're planning on using a friend as a "general contractor." If, by including that in quotes, you're trying to indicate that you intend to do much of the work yourself yet have his name on the paperwork, be careful with how you describe this arrangement to your bank when seeking a construction loan. Lenders tend to be afraid of self-builds hidden as "yeah, my buddy is the general contractor, wink wink."

  • An anonymous user proposed an edit to this answer which I voted to reject because I felt it removed meaningful content (it also left behind two sentence fragments which didn't seem to make sense to me). If anyone would like to discuss any issues with the answer or potential reasons for changing or improving it, I'd love to hear from them here in the comments. – dwizum Dec 12 '19 at 13:31
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    This is the best answer as the loan is an ancillary issue for the reasons mentioned. We lack particulars on OP's location (zoning, lot proportions, etc.) but being able to build a second primary use building on a half-acre lot makes me raise my eyebrows. – Gabriel C. Dec 12 '19 at 15:18
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    Ultimately I think the ancillary issues lead up to a real answer to the actual question of "how do I get a loan?" because the answer is basically, "if you can address these things, then a bank will be able to give you a loan." – dwizum Dec 12 '19 at 15:26
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If the city or county planning-commission will approve the project then the banks can make a construction loan on it. Then after final approval, the construction loan can be converted to a mortgage but the new mortgage must also include the payoff of the other mortgage. Actually, I think the construction loan would have to include payoff of the other mortgage.

A project like this would not be unusual if the new construction matches other upscale development in the neighborhood. The unusual aspect is not demolishing the older house as a first step.

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    The disadvantage of not demolishing first, is that the new house will be further back from the road, so the back yard will be smaller (and the front yard correspondingly smaller). Most people prefer more back yard because of increased privacy there. – Martin Bonner supports Monica Dec 11 '19 at 11:46
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    @MartinBonnersupportsMonica That part could stop the whole thing from being approved in many areas that are particular about structure set-backs. – Hart CO Dec 11 '19 at 16:37
  • @HartCO: I'm not sure I've ever heard of a maximum setback as opposed to a minimum one, but it wouldn't surprise me if there's an HOA somewhere that has mandated such a thing. – Michael Seifert Dec 11 '19 at 18:59
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    @MichaelSeifert If they back to other residential property there is certainly a minimum from the back property line as well. – Hart CO Dec 11 '19 at 19:04
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    A site plan, including water drainage, would be more complicated with two houses but possible. The site plan would have a temporary aspect and a permanent aspect. And the one-half acre lot is fairly small even if the older house is temporary. The lot probably does have a rear set-back line. – S Spring Dec 11 '19 at 22:19
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We have this scenario near me a lot and I even went over it and decided not to build - for specific land reasons.

Some of the advice you have on here is just flat out wrong. You do demolish a perfectly good house if the cost of doing it plus the cost of building new are going to be lower than the future value of the new house. Banks will give you a home loan for this. You have to walk into the bank with the plans and the costs of construction and an appraisal. The banks will send their appraisers out and if you can cover 20-30% and have good credit your chances are very good.

But the whole premise of not demo'ing a good house is ludicrous. If the "good" house gets in the way of future gains, get rid of it. If it is "that good" and still proves to not warrant keeping there are tons of ways to make money on salvaging pieces.

The other option you have is to basically build new house on top of the old one. Pick a wall and join the two houses there. So as long as you are abiding by property line rules the city doesn't have much to say because the "new house" is treated like an extension. I have seen this done 20+ times in my area and most of the time it looks good. I almost bought one in fact and it was done well - the old house was basically the front of the new and had mudroom, laundry, office, small sitting room.

Now the other option that you have is an addition. In 95% of cases an addition on a house is a long-term loss. You really have to be in a high valuation area to gain on an addition. You put a 1000 sq foot addition in for 100k expect your house to be worth 80k more in most areas. That is why I suggested building on top of - that is almost always a winner as building a 2500 sq ft house might be 175k compared to 100k addition.

So it is really about appraising right and math.

Demo cost + Building cost < Value of new house ... if false...

Building new house on top of old < Value of new super house ... if false...

Sell house and go buy new house in the area.

Any other reasoning is sentimental and does not belong on a money advice site!

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