You’re not alone if you’ve ever been disappointed to find a great lot in the ideal neighborhood, only to discover that the house on it is sadly out of date, too small, or just not your style. Location is a key consideration for many first-time and repeat homebuyers when making a purchase. Consider whether a tear-down option is appropriate for you if you have your heart set on a specific lot.
For many homeowners, choosing the ideal location that satisfies their present and future needs is worth going through the process of buying a house (and land), demolishing the building, and rebuilding a more modern or energy-efficient version. Depending on the age of the structure and its current state of functionality, it may result in long-term savings on utility and repair costs. It might be challenging for the seller to remove the property from the market at any price if it is not structurally sound, was not constructed for safety in dangerous weather conditions, or is in poor condition.
If you choose to buy a home that needs work, you should think about the financial aspects. The process of financing a tear down home is a little more difficult than a typical mortgage because it entails destroying your mortgage collateral by tearing down the home.
Lenders desire assurance that, in the event of default, they can seize your house and keep their assets. If you destroy your house, they won’t have much to take back if the new house isn’t finished. Not to mention that, in many circumstances, your mortgage lender may sue you if you make changes to your house that lower its value. It’s best to be truthful and up front with your lender so that they can give you advice about your financing options for your rebuild project.
I’ve put together a quick checklist of financial factors to think about before buying a tear down and rebuild. This covers strategies and options for paying for the purchase of the home that will be torn down, its destruction, and the costs associated with new construction. Of course, before making any significant decisions, you should speak with a loan specialist.
Before You Buy: A Checklist
Be sure to take these preliminary steps before you make any decisions about purchasing property.
Check Your Credit Score
This is the report card for life. You will save a tremendous amount of time, money, and stress by checking your credit report before scheduling any plans or attending any construction meetings. Knowing your credit will enable you to ascertain the loan products you might be qualified for and the options available. You definitely wouldn’t want to hire someone to create new home designs before finding out that your credit disqualifies you for loans.
You should anticipate upfront costs and out-of-pocket expenses regardless of the loan option you select. Prior to meeting with the lender, make sure you have enough cash on hand to cover any additional costs, such as bank fees, loan fees, home design plans, and anything else that may be required.
Pay Outstanding Loan Amounts
It’s possible that you or a member of your family own the demolished house and that there is still money owed on the mortgage. Most of the time, you won’t be able to destroy a house that has a balance owed on it. Ensure that you have full ownership of the property by paying the outstanding balance in full, if necessary.
If the outstanding balance is small, you might occasionally be able to get your lender’s written consent to roll it into your new mortgage. However, bear in mind that lenders won’t approve if your balance exceeds the value of the land, which will represent your only equity once your house is destroyed.
Consider Your Options: Total Tear Down or Substantial Renovations
A construction expert should visit the site to assess the amount of work that will be needed. While some homes might only need minor renovations, others might need to be completely torn down. Existing codes and regulations regarding tear downs in some counties and areas may complicate the procedure and extend your timeline. Other regions might use specialized loan products and tax incentives to promote significant renovations.
Purchasing a Tear Down Home
As was previously mentioned, buying a house with the intention of demolishing it is challenging. You might be able to work out a deal with your lenders by offering them additional collateral, like your current home or a lump sum of cash. Using cash and equity together could be a workable solution.
It’s also possible to use the proceeds from the sale of your current residence and condition the purchase of the demolished house on the realization of those proceeds. This might or might not get the seller’s approval, but it’s worth a shot.
Your home’s demolition may cost between $5,000 and $20,000, depending on the size of the building, its location, and the necessary disposal procedures for hazardous materials like asbestos. Check with the local authorities to see if there are any required inspections or oversights to be carried out before you call in the bulldozer. Obtaining permits and securing the site during the demolition may also cost money.
There are a few ways to get rid of the house for free, though, if you don’t intend to save various parts of it and recoup some of the cost. If they’re willing to cover the costs of moving it, you could donate the house, or you could hire a reputable company to raise the house onto a flatbed truck and move it to a new location. Or you could give the house to the nearby fire department so they can start a controlled fire inside. For firefighters who need to learn how to effectively put out a fire, this can be an excellent training tool.
Loan Option #1: Construction-to-Permanent
The first step in obtaining financing is to speak with reputable lenders in your area to find out what kinds of loans are available for reconstruction and renovation costs. Although not all lenders provide the same products, the three most popular are listed below.
For this kind of project, construction-to-permanent loans are the most common. Buyers of foreclosed homes use a construction loan to pay for the costs of tearing down and rebuilding. After the project is finished, the loan will become a permanent mortgage. Due to the elimination of the separate closings for construction and mortgage, these loans may be referred to as “one-time closes,” saving the buyer thousands of dollars in closing costs.
As a general rule, a tear down and rebuild project should produce a new home that is at least twice as expensive as the one that was originally torn down. Lenders will evaluate whether the projected final home’s value will be sufficient to support the full amount of your new permanent mortgage. Even if you don’t pay back your loan, the lender can still recover the money owed by selling the property.
Loan Option #2: Construction-Only
A short-term loan known as a construction-only loan only covers the cost of new construction. This type of loan cannot be combined with your mortgage payments; it must be fully repaid when the building is finished, usually through a conventional mortgage. As with all mortgages, each lender has different requirements for credit scores, debt-to-income ratios, and down payments.
Lenders typically demand oversight and approval of all building plans, site measurements, financial documentation, and collaboration with preferred design/build firms for any construction loans.
Loan Option #3: Renovation-Construction
An expense for major (or minor) home renovations is covered by a renovation-construction loan. It could be used in conjunction with the purchase price to create a single loan. A renovation-construction loan might be the best option if you decide to buy a fixer-upper and make significant renovations as opposed to demolishing it.
It is possible to use the FHA 203(k) and HomeStyle loans for both significant structural repairs and aesthetic improvements. If you are unable to live in the building while it is being renovated, you have the option to add up to six months of mortgage payments to the loan. As milestones are reached in the project, payments are made to the contractors in draws from an escrow account.
Borrowers needing an FHA 203(k) Standard loan must have a minimum credit score of 500. The required down payment decreases with a higher credit score. The FHA prohibits using these loans for anything it considers to be a luxury. As a result, you cannot use the money to purchase a Jacuzzi or an expensive outdoor sound system. A vacation home cannot be purchased with a 203(k) loan; it must be used for a primary residence. As long as the foundation is still in place, you are permitted to demolish and then rebuild a house using a 203(k) loan.
Borrowers with a minimum credit score of 620 are eligible for Fannie Mae HomeStyle loans, which have low down payments. Homes with significant renovations are the only ones eligible for HomeStyle loans; homes being torn down are not. They have fewer limitations on permitted renovations and can be used as second homes or investment properties.
Build Your Dream Home
You can start by doing some research to get a general idea of how much a tear down and rebuild may cost and how much money you have available. When you have a rough plan, it’s a good idea to hire a builder you can rely on to provide guidance on the details of price and completion date. Set up a call with your lender and/or a loan consultant when you’re prepared to discuss any concerns and make sure that everyone is on the same page.
Melanie Theriault is a writer, counselor, and lifelong learner. She holds a B. A. at Southwestern University, where she discovered her love for using stories to foster human connection.
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FAQ
Can I demolish a house I have a mortgage on?
How To Demolish A House With A Contractor. You should get in touch with your lender if you owe money on your home. You’ll need approval from your lender before proceeding. They should be informed of the planned demolition, and they might even be able to assist you in getting a construction loan for a new building or renovation.
What happens to my mortgage if I tear down my house?
If you destroy your home, the bank will be unable to use it as collateral for your loan or to collect the money you owe. However, if you suddenly stopped making payments, the bank would have no recourse unless it could seize other valuable assets from you, which is unlikely because they would want the house first.
How do you finance a teardown and rebuild?
For this kind of project, construction-to-permanent loans are the most common. Buyers of foreclosed homes use a construction loan to pay for the costs of tearing down and rebuilding. After the project is finished, the loan will become a permanent mortgage.
Is it cheaper to tear down or renovate?
Rebuilding. Consider the options of remodeling versus demolishing and rebuilding your home’s interior to suit your needs. According to The Spruce, remodeling an existing building typically costs 20% less than starting from scratch.