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ADU Financing Guide
Understanding How Financing an ADU Works
Whether you call your Accessory Dwelling Unit a granny flat, a guest house, or a cottage, adding an ADU to your property is not an easy decision to make. It’s an investment, and one that is going to have long term impacts on your property’s market value.
There are a variety of methods to finance an ADU project but they vary significantly depending on the state and local regulations where you live. Be sure to schedule a free consultation with RJ Jaramillo so that he can go over exactly what would apply to your situation.
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How Are ADU Projects Normally Financed?
Since an ADU is typically built on a property where a person’s primary home already exists, most financing is based on the owner’s existing equity, or their future property value.
- Home Equity Line of Credit (HELOC) – many lenders offer this method to people with significant equity in their home. Essentially, you draw funds as the construction process on your project progresses, and you only pay interest back on the money you actually use.
- RenoFi Loan – a RenoFi loan, on the other hand, lets you draw on the future value of your property AFTER you’ve completed your ADU project. It may sound odd, but it is a new kind of option to help encourage more homeowners to take on projects without taking personal loans. Some even offer cash-out-refinancing.
- Cash-Out Refinancing – this option, available from many lenders including the VA, replaces your current mortgage with a bigger one for more than you actually owe, allowing you to keep the difference and turn that equity into cash.
- Home Equity Loan – a traditional one time loan that is sometimes called a “second mortgage” allows you to use the equity on your home as collateral. Many banks offer these at a fixed rate, advertising them for home improvements like ADU’s along with things like debt consolidation.
But It’s Not So Easy with an ADU
ADU’s are still a new concept in certain regions of the US, so there are many lenders out there who simply have not had the experience or knowledge needed to handle these specific types of projects. On the flip side, some states, like California, actually offer incentives to build ADU’s in some municipalities to encourage new construction. No matter where you live, there are several variables that will be involved with any lender:
- Your existing equity on your home and property.
- Your credit score and debt-to-income ratio.
- Appraisal gaps – if there aren’t comparable properties (comps) nearby, a lender may not even consider it.
If your credit score is less than perfect, the interest rate on any kind of ADU financing is going to go up, and vice versa. The loan type will also determine whether you can take advantage of a fixed-rate or adjustable-rate loan structure, which may impact how much you pay over the life of the loan due to market conditions.
And speaking of market conditions – we could write a whole book on the volatility of national, state, and local economic markets on lenders. Think of it like a seesaw – when there’s low demand for loans, the rates are going to be much higher. But if more people are making home improvements, like adding an ADU, in your area, interest rates might become a lot more reasonable.
Where People Get Off Track
Proper planning from the very beginning is the best way to avoid unplanned problems and additional expenses when building an ADU. Your expert, RJ Jaramillo, has seen the full spectrum of experiences: the good, the bad, and the ugly. His guidance can help you avoid:
- Underestimating project costs. Planning from the very beginning, before looking for a lender, is the best way to be sure to avoid coming up short.
- Local and state regulations. You’ll have to look into your city and state’s zoning laws to be sure that your ADU project will be up to code with regards to the distance from your main property, the lot size, even how tall the ADU can be.
- Even more rules. Some states require you to have a licensed architect involved if an ADU is two stories high or more. Others require contractors with special licensing, different building permits, or even more red tape if you’re planning on using the ADU as a source of income.
Start With the Big Picture Plan
When you understand what's available to you first, you can build a project around it. There may be more equity in your current property than you thought, or the building of an ADU on your land might open up the opportunity to be closer to your grandkids. Whatever the motivation is for building and ADU, there is a path towards financing it properly.
Book a Free Consultation
If you want to understand what financing might look like for an ADU building project for your specific situation, book a free consultation with RJ Jaramillo.
He'll walk through your land, equity options, your goals, and your project structure together — so you can move forward with a better understanding of the options in place for you in your town.
Disclaimer
Financing options, zoning rules, and construction requirements vary by state, county, and municipality. Always review your specific plans with a qualified professional before taking action.
Financing an ADU project? Here's where to start.
RJ Jaramillo can eliminate the confusion and set you up for a successful project that makes the most out of your existing equity.