Building a new house to replace an existing mortgaged house

Question

I know that others have posted similar questions but I don't think any I've seen so far relate to our exact situation. We bought a cottage in Nashville, TN about 15 years ago that was right for our family at the time but we are now starting to outgrow as the kids have gotten older and more numerous. In this time the property values have exploded and the land value alone for our property is now worth at least $100k more than we bought the land and house for. We love the neighborhood and our lot and we probably could not sell and buy a bigger/better house in the same area for the same amount that it would cost to rebuild on our own lot. Plus we could build exactly what want and fits our families needs rather than buy a speculative teardown/rebuild that an investor is trying to maximize his profits on. (There is a LOT of that going on here lately, the tear down one 1000 sq ft house and build two 3,000+ sq ft houses trend that has hit most of Nashville lately.)

So here are the specifics for our situation:

• Current total property value is about $500k per Zillow and recent neighborhood sales

• Land value alone is approximately $350k (very conservative estimate)

• The remaining balance on our Wells Fargo mortgage is about $175k

• We plan to build a roughly 3,000 sq ft house that I estimate would run about $300-350k in construction costs, with considerable sweat equity on our part

• Similarly sized new construction homes on much smaller lots regularly sell for $750-800k in our area

• Although the siting of the new structure would be in same location on the lot I do not think that we would be able to reuse any part of the foundation due to change in the layout and the condition of the foundation (1930's rubble stone basement with numerous past repairs). So I think renovation loans are out of the question in our case.

So I think we are in a good position from a starting equity standpoint compared to other posts I've seen on this topic. But here are my questions:

1. Would we need to get a construction loan from the same company as our primary mortgage holder (Wells Fargo) to keep the lien with only one company until construction is complete?

2. Is there a scenario where I could finance the land purchase from myself for the balance of the mortgage ($175k) and roll that into a construction loan?

3. Being somewhat ignorant of how construction loans work, because we've never had a house built before, do loan payments have to be made while the house is under construction or do they only begin when the project is complete and we're ready to move in? We would obviously have to move out and rent during this construction period so I'm trying to find out if we'd have duplicate living expenses during the construction or if the mortgage payments can be, or by default are, deferred.

We're still very much in the planning stages for this project, and probably won't actually execute it for 2-3 years from today, but I feel this is ultimately the right solution for our family. Just looking for some knowledgeable advice to get us started for the planning stages.

Thanks in advance!

Answer 1

It is not common for the existing mortgage company to approve a teardown project like the one you are proposing, but with the land value what it is, you can try to make the case with them. Your current mortgage company might not offer new construction loans. In any case, it should be possible to get a new construction loan which includes a payoff of the old mortgage assuming you qualify otherwise.

Before you start the process, you should consult your city planners to be sure there are no prohibitions against a teardown. There are some housing districts that are considered "historic" and teardowns are either completely prohibited or there are strict architectural styles enforced on the replacement structure. Even if you don't have historic concerns, the local planners can help you avoid any other pitfalls that would avoid their approval of a permit.

Some other things to consider is that in addition to the cost of constructing a new house, you will pay $10k-$20k to have your house demolished and the resulting mess removed. If you are doing a teardown on your primary residence, you will have to find a place live while waiting for the construction of the new home. Consider the costs of rent when making a financial plan for this project.