Demolishing Property Under Mortgage

[Gazz]

I have an investment property which I intend to develop by demolishing the existing house and building 3 new units on the site.

The existing house/land is mortgaged to (by?) a bank.

To minimise borrowing costs I will be demolishing the existing house, subdividing the land and obtaining titles for the subdivided blocks prior to applying for finance (with the same bank) to construct the new units.

My questions are;

Do I need to get the permission of the bank holding the current mortgage in order to to;

a) Demolish the existing property (As the existing house/land has been offered to the bank as security for the existing loan)
b) Re-title the land into three subdivided blocks?

At what stage would the bank usually get involved?

Thanks for your help

 

[Peter_Tersteeg]

You'd generally get the bank involved right up front, well before demolishing or sub-dividing. The bank will find out about it as they hold the title which is needed for the sub-division.

If you demolish without their permission, you could find yourself having to reduce the existing loan substantially before they let you proceed.

 

[morty]

Hi Gazz,

I demolished a property earlier this yr without telling my bank (westpac) and they weren't too happy when they found out! They didn't do much about it though as i'd replaced it with three brand new townhouses through private funding but it would be worth letting them know beforehand i think.

I didn't deliberately not tell them by the way, it was just something i'd overlooked! Lesson learned for next time though.

Morty

 

[Aaron_C]

You should let them know your plans well beforehand in order to get finance ready for construction and also because as a mortgagee they have a right to know if anything substantial like that happens to the property. This is why they require you get building insurance before they give you a loan..

 

[Ian (WA)]

Gazz,

I went down the same path as Morty, my initial loan was with ING Direct. I didn't inform them of the demolition at the time.

When my conveyancer went to process & lodge the community division of title in Adelaide there ended up being a six month delay as the LTO in SA contacted ING being the mortgagor and from there both parties just sat on everything.

I knew my conveyancer was going overseas for a few months so I didn't get too bothered by not hearing from him. Eventually I did ring to see what was happening and he was equally surprised to hear from me because he thought all the titles had been signed off and mailed out to me given the time that had elapsed.

Bottom line is, it then took another two months to grovel to ING for not informing them, then they played inter-office ping pong with my file for three more weeks before they finally gave the file to their legal people in Adelaide to take it through to settlement.

Mate, just tell them up front what you're doing and make sure you allow extra time for the processing & settlement of the new titles.

Aaron will be able to clarify here, but even though you are with the same financier you may have to discharge the existing mortgage i.e. settle - and then strike up a new arrangement for the construction.

For our 3 x townhouse build in Adelaide we had to get a commercial loan with CBA because nobody else would play - not even ING. The sentiment in bank circles back then was that any resi construction for 3 or more dwellings was considered commercial. The irony was that when both my broker & I got to speak personally with the CBA Business contact in SA, he said WTF has this ended up on my desk for....it's a resi lend!! So he argued the toss within CBA but met deaf ears so he ended up running with it so we could start construction. So we had to take the 8.1% rate for building but will take it back down to resi lend rates as soon as we have the keys in Feb.

Hope all goes well with your project.

Cheers!

Ian.

 

[Terryw]

Demolishing a house on land that is mortgaged will certainly be a breach of the terms of the mortgage. Have a read of your mortgage conditions. Breaching will probably mean the loan can be called in immediately - or within a short time.

If you don't have any other assets then the bank could be in a bit of a bind, but if you do, then you could be.

 

[Aaron_C]

Exactly right Terry. It changes the entire nature of the security - and in fact it probably devalues it because the value of the house is no longer attached to the property as per the valuation report. This could mean a $200,000 haircut to the bank straight away.

 

[mattnz]

If you have a DA for the new townhouses, surely the land value has improved more than the value of the existing house without the DA was ever worth. You should have higher equity, despite the house not being there.

 

[Aaron_C]

If you have a DA for the new townhouses, surely the land value has improved more than the value of the existing house without the DA was ever worth. You should have higher equity, despite the house not being there.

Not always. But even if it does - then the nature of the security can become commercial - and that is an entirely different ball-game to a vanilla residential home loan.

 

[mattnz]

I actually have a similar situation. I have a house on a corner block. I have received council approval for a DA for 2 townhouses on the block in addition to the existing house which will remain. All 3 dwellings will be strata titled.

My town planner has advised I should get the strata title completed prior to building. How does this work with the bank? I am intending to end up with 3 separate loans, rather than cross collateralised and was initially advised by the bank that I could do a residential loan for the build. They had also advised that I wouldn't be required to add any funding for the build as there will be significant equity in the developed property.

I expect that the original house, when strata titled, will still be worth what I originally paid for it and would have the 2 townhouse sites unencumbered. Any idea how they are likely to value strata titled but (as yet) not built townhouse sites and are they likely to lend against the value of them?

Each completed townhouse will have a total build cost (incl. council contributions etc) of around $300k and have a finished value of $520k, so in theory each site has a value of around $220k.

Thanks,
Matt

 

[Aaron_C]

Well you'd have to get the subdivision done, which requires the construction of the common driveway, connection of sewerage/services etc and the establishment of the body corporate. After that has been done, and you obtain the new titles for the (empty) blocks of land, you can take them to any bank as unencumbered titles and obtain leverage off it.

How much leverage? It really depends...Generally though for these kind of small developments, you might be better off going for a residential construction loan to build the townhouses because you can get a 80%+ lend with a fixed price contract. However, if you don't have enough serviceability (and this would require a lot of income), you might be able to go down the commercial route and get it over the line with some pre-sales or if you have other assets that you can offer as security if you don't want pre-sales.

I'm not sure how they will value it but don't forget that the bank may discount the GDV of the property due to GST/margin scheme etc. Always keep that in the back of your mind and valuers are always conservative so it's best not to overestimate your land values.

 

[mattnz]

Great thanks Aaron, always appreciate your input.