I can't comment on if there was discrimination or not in your case as I wasn't involved, but the above requirements would be in place if Jeff Bezos called me for a loan to develop a new Amazon Warehouse and was willing to personally guarantee it and pledge his personal mansion and pay triple the normal mortgage broker fee.

But not pull the equity to pay off mortgages just yet.

First, there is no institutional lender that I know of that would touch doing a HELOC behind a mortgage that did not belong to the borrower.

I am getting only 1.5% returns without taking into account the equity building portion.Mortgage tax write off is 0 as I currently pay mortgage on my primary residence.I have used this property as my primary home for 2 years in last 5 years.

Traditional bank loans might not be in the cards just yet due to your income history, but don't let that stop you.Enter the world of hard money lenders and private money lenders.

Back to finance question, would it be a better decision to take the funds from the sale of the 2 acre lot and pay off the current mortgage (~$150k) and live in the current home for a year or so (in hopes that interest rates will go down) then refinance that take out $400k from equity (~$750k) to build new house? 

If you're going to use the money for a long-term investment I would go with a standard 30-year fixed mortgage.

The 1st mortgage was extended by 32 months.

We are not seeing a mortgage on this house. 

I know this is because I have been focused on the DTC/SF traditional mortgage options or funding with buying an existing structure, but I can't see a clear path to financing a 2-fam new construction that's owner occupied (allowed by right per zoning).