Construction loan advice

[Sol Dubnov]

Thanks to all who take the time to answer. Here is our situation: we own a primary residence on which we own a mortgage and we've recently made a cash purchase of a lot from a foreclosure in a highly desirable area. We plan to build a house on that lot and move there, and rent out our current residence for extra income.

We are currently in the final stages of pulling permits from the city and have a couple of attractive bids from contractors. The final estimated value of the new house is good so it seems as a sweet deal. The problem is that we have spent pretty much all of our resources on the purchase, the plans and permits. Now when we are trying to get a construction loan, things get complicated.

When we approached the lenders, one of the lenders claimed that we need, in addition to the lot as a collateral, to have additional 25% of the construction costs in cash reserves. Another issue that came up was the payback capability - for some reason the lender said that we need to have enough income to pay back both the future payments on the new house AND the mortgage payments on our current residence, which we plan to rent out. If we have to count for both, this is more then what our current income allows at this point.

An advice that the lender gave us was to move out of our current home and rent it, so it shows as income, and only then apply for a loan. Money-wise this is not a smart move, not only because of the hassle of moving to a temporary place, but also since the rent we would pay in another place would be more then the mortgage payment we currently have. So it does not seem to make sense.

Another option is to sell our house, but even if we do that, after paying off the mortgage balance, the remaining equity will not be enough for completing the construction. I presume it will solve the cash reserves issue, but I'm not sure this is the right move as well. We were hoping that the future income from renting out our current house could be counted for in terms of the payback capabilities, but now we are not sure anymore. Or are we talking to a wrong lender?

thanks,
Sol