Deconstruction Constructionand a Mortgage to Pay for It

Some people find a house and can't wait to move into it. Others find one and can't wait to tear it down. Getting a mortgage for that first home, the one you plan to move into, is fairly simple. But how do you get a mortgage for the home you want to demolish?

In the vast majority of mortgages, the home is what secures the loan. Lenders know if you default on your monthly payments they can repossess the house, sell it, and get their money back. But what secures a home loan when the home is gone? The answer is in the land on which the old home sat and where the new one will stand once it is built.

The first thing to realize if you find yourself in this situation is that you are actually looking for a construction loan--one with some extra money thrown in for the destruction of the original home. While the need for this type of loan is not exactly sweeping the nation, it is becoming more common, explains John Parsons, vice president, construction lending for Countrywide Home Loans in Plano, Texas.

"Tear downs are a growing trend," he says, adding that they are the logical result of urban growth and development. "A large percentage of areas all over the country are built up." As a result, it's more likely that once you find the area where you want to live, there won't be a lot of housing available, especially in the built-up and most-desirable urban areas. "You might find a great lot in the neighborhood you want, but often there is a house sitting on it that you don't want."

This is where problems can develop unless you have the right type of loan. If you buy a house and that house is collateral for the loan, you cannot legally do anything to reduce its value, such as demolishing it. "The borrower has to get approval from the lender to tear down what is, in effect, the collateral. The lender has a lien on the collateral." Destroying collateral without approval is, Parsons adds, "a violation of the mortgage contract."

Of course, there are some advantages to both the buyer and the seller when the house is being sold just so it can be demolished. First, there is no need to have the house appraised or inspected. The sellers also can usually take anything out of the house they want to keep: fixtures, fireplace mantels, even doors and other items typically left behind when a house is sold. When they do move out, the sellers don't even have to clean up. The demolition crew will take care of that for them.

The typical demolish-and-rebuild buyer is very "upfront with us about his or her plans, and we have a loan designed for just that purpose," says Parsons. Countrywide's loan, like those offered by other lenders, is structured much like a construction loan. Money will be released as needed, and the buyer makes interest-only payments on the money once it is released. First comes money to buy the house, then more to demolish it, and then additional funds are made available to build the new one. Once the house is built and the buyer takes possession, the borrower has a variety of loan packages from which to choose.

As you would expect, the process is more complicated than for a normal purchase. "If you are buying a home with the intent of tearing it down," Parsons says, "the appraiser must ignore the value of the old house, and determine the value of the lot and the new house." One of the oddities of the process, he adds, is the value of a lot in this situation "normally increases when the existing home is removed from the equation. That's because people choose to buy the least desirable and most affordable house on the block. It is usually one of the oldest houses--the one that needs the most work. The value of the lot should actually increase when you scrape off the existing home. Razing the home generally improves the value enough so that it covers the entire purchase price."

Destruction and rebuilding is not for everyone. "The people who do this usually end up with a mortgage at the higher end of the scale --in the $400,000-and-up range," says Parsons. And the fact that it's a purchase and teardown does not change the basic requirements: a good credit score, employment history, and enough cash and income to allow you to live where you are until your new home is ready. In cases where the value of the "improved" lot does not cover the entire cost, you also would have to add additional funds to the down payment in order to maintain the proper loan-to-value ratio.

Parsons says that although tearing down a home is expensive, "Sometimes it costs as much to demolish and rebuild as it does to rehab a house. With an older home you don't really know what you're getting into until you start. You may find all the wiring needs replacing, as does the plumbing, and then you discover the insulation is not that good. Then you find other parts of the house aren't up to standards with current materials and practices. Needed replacement costs keep adding up to morph your home into the one that you want. Often it's just as cost-effective to rebuild as it is to change a home you don't want into a home that you do."

After all, we're all looking for our dream home on that perfect lot in that ideal neighborhood. Today, more and more people are just looking for the perfect lot in the ideal neighborhood. The dream home will come later-once you do a little constructive destruction.