Home rebuild fraught with obstacles

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Dear Real Estate Adviser,
My husband and I plan to knock down our old home and replace it with a new one on the same lot. Should I go to the bank for a construction loan or a home equity loan? The value of the current home is about $300,000. What are some of the other issues to consider with this sort of plan?
— Jennifer

Dear Jennifer,
What you are pondering is referred to as a “knock-down rebuild.” Any number of design-and-build construction firms can handle this. Or, you might opt for a construction consultant to walk you through all the options, coordinate the hiring of the contractor and the architect and to contain costs.

However, whether your demo plan will work depends on how much added value you plan to create in the replacement home, and to some degree, your neighborhood’s dynamics. If you plan to downsize or build only a slightly more valuable home, the numbers probably won’t add up. The bank would rightfully be concerned that the new home might not create enough additional value for it to recoup its money should you default. I might add that five years ago, you would have almost surely gotten the green light for such a project. These days, however, the loan approval process has gone from full throttle to closed throttle in many instances.

In some desirable parts of the country, where older, functionally challenged $300,000 homes are being razed and replaced with $1 million brick homes, your sort of plan has worked well for owners and lenders. Unless you’re similarly positioned or unless you have substantial equity in the current home, can pay for the teardown out of pocket plus produce 20 percent or so of the down payment, you may face stiff challenges to finding affordable financing. In most knock-down rebuilds, the larger the replacement home, the less of a default risk you are considered.

In any event, you will need to produce exhaustively researched numbers for the lenders on construction costs and the estimated value of the replacement home as well as its design. The design is important because the lender will want to know that the new home will be built in context with existing neighborhood homes. By the way, it’s unlikely that a lender would give you a home equity loan, as your question asks, on a house that you are demolishing unless the land is extremely valuable.

Also, some cities have strict permit policies on teardowns or are in the process of amending zoning laws. Before you spend any more time or money planning this, find out from the city whether a demolition is even permitted. Also, don’t forget to factor in the cost of alternative living arrangements while your replacement home is being built. Based on your home’s value and presumed living needs, that could set you back at least $10,000 in rent.

You might instead consider a comprehensive remodel that would involve a partial demolition, some new construction and significant upgrades. This would help assure the home’s continuity with the existing neighborhood. Plus you would be able to live there at least for part of the process. Alas, in many cases, it’s actually less expensive to demolish a home than rebuild.

There are a lot of moving parts to this, so make sure you research this one thoroughly!

Good luck.

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