seasider72:

What are my best options? I would prefer to keep my 1st house if possible as an investment for the future.

You can either take out a second mortgage on the first property or take out one large mortgage to pay off the £65k as well. It is possible that the early repayment fee will make the first option preferable.

If you talk to an independent mortgage adviser (s)he will confirm the details but if you could take up your total borrowing on the first property to £300k, you could repay the £102k and have finance to get started with your planned demolition and self build. Once you have this finance and planning permission, you might be able to get a self-build mortgage that would let you complete the project.

Obviously you do not want to start such a project unless you were fairly sure that you will be able to complete it so it is important that you discuss the plan and anything that could prevent completion for the self-build mortgage with an independent mortgage adviser or two as well as with the planning department of your local council.