Tear down my house and rebuild -financing?

weed30March 9, 2009

I was going to move, but am now considering tearing down my house and rebuilding. Area is very solid, and has been hit by the economy, but not badly. Location is outstanding.

A few facts:

> The street I live on has small and very basic homes built in 1950. Homes all around this street are priced from 350K to 800K. They are all larger, some built in the 60's and 70's, others are new.

> Two homes on my street were torn down and after rebuild, sold for about $600K in the past 4 months.

> Desirable area due to location and top school district.

> Over half the homes are owned by builders or real estate companies. Purchase price for the teardown homes is usually around $150K, new builds sell for around $600K. They are still building, so at least in their minds, the market is ok here.

> Nearby subdivisions are also teardowns/rebuilds, and these new homes are selling at an acceptable pace, ie, on the market less than 3 months. (which is good in this economy, I think.)

So how does one go about this? I owe about 70% of the current value. I intend to build a smaller home, 1200 - 1300 sf as opposed to the 2500 - 3500sf homes being built. (not even sure if the city would allow that.)

Is there a type of contract where you sell your home to the builder, then when they build it you buy it back at a pre-agreed price, or do you do a "tearing down my house/rebuilding it" loan?

Sorry, but I am clueless about how this works!

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To justify a teardown and rebuild, a bank is going to want to see a substantial difference in the before/after type of property. In other words, unless you have a lot of equity and can pay cash for the teardown to build a smaller house, it's unlikely that a bank will work with you on financing except at the highest rates as they stand to lose the most if you default. If the home is at least a larger property well within the character of those other homes being built from teardowns, it's less of a risk to them if you default.

You only have 30% equity in a 150K teardown home. Do you have savings to pay for the build in cash? Does your income qualify you for a loan for the price of the 600K homes around you?

The only way I can see this happening if you don't have a pretty high income or sustantial savings is if perhaps a builder would take a chance by subdividing your lot and building a couple of homes on spec for his fee in building yours. That's happened here in a very choice neighborhood with older homes, but that was before the market stalled. That route has also been somewhat more regulated here of recent and subdividing the lots isnt' just rushed through zoning anymore since a few neighbors have objected to the infil developing.

    Bookmark   March 9, 2009 at 10:26PM
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You're scenario is similar to what we did. We had more equity and took out a line of credit before the tear-down. I did not ask the mortagage co for anything. We added our own money for the rebuild. I am not advocating this aproach and was prepared to pay the mortgage off if the things went sideways, which they nearly did on several occasions. The saving grace is that the property is now worth substantially more then the debt against it.

    Bookmark   March 9, 2009 at 11:47PM
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Oy. Well none of that sounds very promising! I'm not sure what my income would qualify for. I am 50, divorced, plan to stay that way, no dependents. Car is paid for, no cc debt for the past 3 years, and prior to that low income to debt ratio on cc's. Currently I use my cc's and pay them off each month, credit rating in the high 700's. My job is solid, although I don't know how lenders decide that when considering a loan.

    Bookmark   March 9, 2009 at 11:51PM
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I do have some decent savings to put in the pot, but not enough to pay off the mortgage on short notice.

    Bookmark   March 9, 2009 at 11:55PM
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Your neighborhood sounds very much like mine (DC suburb). Around here, folks go two ways on the updating. Sometimes a newcomer/builder/investment firm will buy the old house and do a complete teardown with the mortgage based on the new build's expected value-- and I've been told interest rates are very high but so is the profit; OR the present owner does a complete remodel around the old house, which has the advantage of slightly better interest rates. Several design/construction companies specialize in this sort of work and you can't even tell that the finished product was originally a remodel.

I think you will have a problem financing to build something smaller. Banks still seem to be under the impression that bigger is better than whatever was before, and downsizing possibly won't bring the finished project up to the prior valuation, much less raise it enough for the bank to be sure it will get its money back in event of default. You aren't planning to default but they don't know that for sure and must take the contingency into account.

In your shoes, I'd concentrate on both paying down the present mortgage and building a savings account (or money fund or other investment), while studying and planning for the new house. Once you have the "new" house completely planned for (and all the design decisions made), you'll be able to determine the expected cost of the build, which in turn will give you firm figures [not blue-sky guesswork] to discuss with various loan institutions.

    Bookmark   March 10, 2009 at 7:23AM
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The 1st step is to decide what you want to build and figure out how much it will cost. Then ask a realtor to figure out how much the new house will be worth. The bank will probably loan 70-80% of what the new house will cost so you will have to find a way to get the 20-30%. Your current equity counts toward that number, but remember it is on the new value not the old one.

From a bank's perspective it is no different that building on a lot that you already own. They don't care about the style or sq. footage of the house, just what it is worth.

You can hire a contractor to build the house without selling them the lot. You can negotiate a fixed price contract if that is what you are comfortable with. Just have some extra money available for the inevitable upgrades. I personally haven't met an upgrade I didn't like, but maybe that is just me. HTH

    Bookmark   March 12, 2009 at 3:19PM
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Beware of one thing when dealing with a bank and doing a teardown - unless you make it very clear to the bank that you intend to tear the house down, they will end up being very concerned when it starts to come down.

We recently had a situation where we bought a house and took out a mortgage for only about 50% of the bank-appraised value. We bought the house because it was a fixer-upper and we wanted to tear it down and rebuild. It was in very bad condition, and everyone else looking at it during the time we were making an offer on it felt the same way...there's no way someone could have lived in the house for long without fixing it up. We even told our mortgage contact at the bank that we were planning to tear it down and rebuild (with our own cash not a construction loan). He seemed supportive and commented many times on what a great lot it was and how nice it would be when the house was "done." So, it was clear to everyone involved that it was planned to be a teardown.

Long story short(er!) - we bought the house in Sept, and in January, when we had our completed architectural drawings, structural drawings, had received building permits and were ready to start demolition, one of the final items on my list was to obtain "course of construction" insurance, which takes the place of homeowner's insurance when you are dealing with a construction/teardown project. In the process of signing the insurance documents, I noticed that the insurance company wanted to know if the bank should be listed as an additional payee in the case of a claim. I called the bank to ask if they're typically listed on a course of construction insurance, and after speaking with a few different representatives (none of who knew anything!), I was transferred to the office of the VP of Risk Management (or something like that)...anyway, someone on her staff almost had a fit when they heard that we were about to tear the house down. She kept saying that our house is the "bank's collateral" and not ours to do what we wanted with and that we could not proceed until we had the appropriate bank approvals, etc, etc.

Keep in mind that we were not asking for the bank to pay for the construction, we are paying for the construction in cash, and we had an appraisal (done by the bank's OWN appraiser!) that was completed in September which showed the value of the entire property to be $1,100,000; they even broke this down between the lot value (approx $950,000) and the house value (approx $150,000). We have a mortgage for $500,000 so obviously, even in a worst case scenario, if the house was torn down and never rebuilt, the bank has FAR more collateral in the land than they ever had in the rickety old decrepit scary house!! Still, this person INSISTED that she had to go to some sort of approval committee and get approvals before we had a demo truck even enter the property.

My husband and I were furious (although also somewhat bemused by this bizarre lack of logic and ridiculousness) and we spoke with several others at the bank who listened to our story and believed us when we told them that we had been very clear with the mortgage person during our loan approval process, telling him all the time that we were buying a "teardown"!! Our point was that, if there were further approvals necessary, he should have told us about them up front. Finally, we had a senior VP reluctantly agree with us but we are still being hounded by this VP of Risk Mgmt who is still insisting that we need to forward her a copy of our contract with our builder, our approved architectural/structural plans and all kinds of other info! At this point, we're ignoring her (because we have the approval of the senior VP), and construction has started, but this has been a big pain and total surprise.

I'm telling you this long story because it just illustrates how crazy and upside-down the banks are these days and how their underwriting/loan approval processes have gone wildly from one end of the spectrum (super wide open) to the other (absurdly tight). My husband and I are the perfect clients for them - we have stellar FICO scores, have a longstanding history of repaying all our prior mortgages (two of which were with them), and MOST importantly, the bank has MORE than enough collateral in our current property to cover it all even if we never paid another dime!!

So, I'm sorry to say it, but like others have basically said, I would be surprised if you get a construction loan with your current situation, and IF you decided to and could somehow do it on a line of credit or home equity situation, BEWARE that the bank will have a fit if/when they find out that you're tearing your house (otherwise known as the bank's collateral) down.

Sorry, I don't mean to be a bummer about all this but it's best to go into it with eyes wide open and know the current lending/housing environment. Whatever you do, best of luck!!

    Bookmark   March 12, 2009 at 5:27PM
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I appreciate the time it took for you to write that post! Fortunately, I used to work for a bank and have friends in very high places, which is actually where I would start if I decide to explore this. Truthfully, the biggest thing holding me back is the stress of building a new home. I did a 40% gut of my last home, and was the GC. (wasn't working at the time.) I ended up getting the entire project done in 9 weeks, which in retrospect was amazing. (siding, roof, all doors and windows, removed 5 walls, new kitchen....) My real job is an event planner, so I do have some good experience in coordinating a lot of "stuff". Even so, there were some extremely stressful moments, like when half of the new doors and windows were the wrong size. (Supplier's decision to try and use stock sizes....NOT.) Then there's the little part about having to live somewhere else while it's being built. I have 3 dogs. Say no more!

    Bookmark   March 12, 2009 at 8:16PM
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Am doing so right now...

Rather than type, here is my blog on it.


In Naperville, IL - extremely desirable area outside Chicago. The worst part of the teardown is the permit process - pretty strict.

Most teardowns sell for $750k on up to $2-3 million...we paid $250k for the house we tore down - will spend about $350k to rebuild - will probably appraise on low-end for $750 - $800k, even in down market (I am GC'ing it myself).

Bank salivated over the equity that will be there...we had no trouble getting a loan (back in Oct 08)

    Bookmark   March 12, 2009 at 8:24PM
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You're smart to acknowledge the stress factor as one of the biggest disadvantages to doing a project like this. I really don't know what has compelled my husband and I to buy "fixers" over the years because each and every time, it is SO stressful! We keep thinking that it won't be, but it always is. Still, we're getting better at it and always come out great in the end (both financially and as a couple)! Knock on wood that the same will be true this time. All the best to you!

    Bookmark   March 12, 2009 at 9:34PM
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CookPR - While I find it hard to believe that most teardowns in Naperville cost $750k-$2/3 mil, I enjoyed reading your blog. You've done a great job. I have a teardown in the Hinsdale / Clarendon Hills area that I hope to have the same success with.

Continued success with your project.

    Bookmark   March 13, 2009 at 3:37PM
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Congrats - have you started yet? We had looked for a long time in Clarendon/Westmont/Downers/Naperville for a lot - they are all such great places - but we had previosuly lived in Naperville and that extra bond/memory put Naperville over the top for us.

In terms of your question about $750k on up to 2-3million - I think you would be hard pressed to find any finished teardown done at a custom level for under $750k in any of the communties I listed, much less Naperville. Over the pat 3 months -several have closed in the blocks around my house - one closed at $900,000, another at $750,000 and a foreclosure I think took the low bar in the high 600,000's - guy behind me just threw one on at $1.1million - and I am 6 blocks north of the Metra - 11 blocks north of downtown - so my area is not even as desirable as ones closer to downtown. Its not a challenge or anything - but if you have seen completed teardowns for under $750 - send me the link.

Good luck and keep me posted. I would love to be in Hinsdale - but that is a wee bit much for my pocketbook.

    Bookmark   March 13, 2009 at 10:27PM
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CookPR - Sorry, I misunderstood. I thought you were saying the OLD house was $750k+. I can easily believe finished houses would cost that much.

    Bookmark   March 15, 2009 at 9:19AM
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