The ability to finance an ADU is often a determining factor in moving forward with a project. Conventional home mortgage products have not always been inclusive of ADU projects, however these restrictions are loosening and it is becoming more common for ADUs to be considered as part of the larger primary residence construction or as a stand alone project. However, recent regulatory changes now allow future rental income to be considered in certain conventional lending options. Be sure to consult a loan officer for more details.

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FINANCING OPTIONS

Self-financing

A place to start is for the homeowner to examine their liquid assets (savings, market investments, etc.) to determine if they have adequate resources to pay for part or all of the project. The remaining options covered in this section are for homeowners who are not able to self-finance the entire project or opt not to do so.

Refinancing

Homeowners who have owned their residences for three, five or more years may have developed sufficient equity that they can refinance at a higher level of borrowing and use the resulting cash to fund the creation of their ADU. With the recent increase in mortgage interest rates, this option is not as attractive as a few years ago.

Refinancing of mortgages result in a lump sum loan made available at one time to finance the ADU project and construction as it moves forward. Monthly payments for the refinanced mortgage begin when the funds are made available to the homeowner.

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Home Equity Loans

Homeowners who have built up considerable equity in their homes but who have limited liquid assets could consider using a home equity loan to finance their ADU. As with first mortgages or refinances of first mortgages, home equity loans provide a lump sum payment and loan repayments commence when the loan Is made.

Whether it is preferable to take out a home equity loan or refinance their first mortgage would depend on prevailing interest rates, fees, and available durations of these different products. Home Equity Loans have fixed rates of interest. Home Equity Loans and HELOCs (below) usually have shorter allowable loan durations than first mortgages.

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Home Equity Line of Credit (HELOC)

As with home equity loans, this product is available to homeowners who have built up adequate equity in their primary residence. As the name implies, a HELOC establishes a line of credit with a lending institution against which the borrower can withdraw cash as needed, rather than all at once as with Home Equity Loan. This can be helpful for an ADU project where expenditures may be spread over many months. HELOCs usually require interest only payments for a period, say 5 or 10 years, and have variable interest rates. At or before the end of this period, the borrower is required to initiate repayments on an amortization schedule with a fixed interest rate.

Renovation Loans

Several products are available to finance home renovation, including adding an attached or detached ADU. Fannie Mae, the FHA, and the VA all offer such loans. Terms differ between these products, but they all generally require that the renovations be done by a licensed contractor within a six-month period. They may allow longer repayment times than home equity products. Renovation loans have not been widely used recently due to several factors, including
changing construction costs and prolonged construction windows. However, they remain an attractive option.

Construction Loans

Construction loans are generally short-term loans (a year or less) to finance the construction phase of a primary residence. Multiple draws can be made to provide funds as needed
during the construction phase. Interest rates are usually higher than for a mortgage or home equity type of loan. Construction loans might apply for an attached ADU renovation project but may not be applicable to a detached ADU. One local lender has introduced a bundled construction-mortgage product that relieves the borrower of applying for two separate loans.

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Combination of the above

The homeowner might combine two or more of the above options to create their ADU. For example, a homeowner might self-finance part of the project and borrow the
remaining funds.