This article does not constitute financial advice. You should speak to a qualified financial adviser to determine the best solution for your ADU.
Accessory Dwelling Units (ADUs) are getting more and more popular every day, so it’s only natural that financing options are also becoming more popular and widespread.
While the benefits of ADUs are pretty clear – including extra living space, rental income, and more – financing an ADU can be complex.
In this guide, we’ll take you through all the financing options that are available for an ADU project, as well as the pros and cons of each so you can figure out which one is most suitable for you.
Why Consider ADU Financing?
Investing in an ADU can not only provide you with extra living space, but it can also be used as a functional space for many different purposes.
You can rent them out in certain places, use them to house family members or friends, and much more.
For many, an ADU represents a long-term investment that pays off both financially and personally. However, financing such a project requires careful planning and understanding of the available options.
ADUs can significantly boost property value, up to 35% in some cases.
For homeowners in high-demand urban areas, this can translate into substantial equity growth. Additionally, ADUs can serve as rental units, providing a steady income stream that helps offset the cost of the initial investment.
Common ADU Financing Options
Financing an ADU is a very personal endeavor that balances on your own circumstances and what types of finance are available and suited to you.
Let’s explore the most common ways that ADUs are financed.
Home Equity Loans
Home equity loans allow homeowners to borrow against the equity they’ve built up in their property.
This option typically comes with a fixed interest rate, making it a stable choice for those who prefer predictable monthly payments. Home equity loans are ideal for homeowners who have significant equity in their homes but don’t want to refinance their entire mortgage.
Cash-Out Refinance
A cash-out refinance involves replacing your existing mortgage with a new one that’s larger than what you currently owe.
The difference between the new loan amount and your current mortgage balance is given to you in cash, which you can then use to finance your ADU. This option requires sufficient equity in your home and generally comes with lower interest rates compared to personal loans.
It’s a good choice if you’re looking for a single loan that covers both your existing mortgage and the cost of the ADU.
Construction Loans
Construction loans are specifically designed to finance the building of new structures, including ADUs.
As you’d guess by the name, these loans cover the cost of the construction and convert into a standard mortgage once the build is complete.
These loans will give access to funds as needed according to the construction timeline, so they’re quite useful for managing larger ADU construction projects.
The downside is that they often require more paperwork and higher credit standards than other loan types.
Personal Loans
Personal loans are straightforward to understand, but they are not an option for everybody.
This is because personal loans rely heavily on your financial stature and credit rating, as well as being able to find a lender who understands your situation and will loan you the money without using the equity in an existing property.
Personal loans tend to have much higher interest rates and short payment periods, so they should only be considered if you’re confident you can pay them back easily, even if the build goes over budget.
Government Programs
In some regions, local governments offer programs that provide financial incentives for building ADUs.
These programs can include low-interest loans, grants, or tax incentives. For example, in California, certain cities offer rebates or waived permit fees to encourage the construction of ADUs. If you’re interested in taking advantage of these programs, it’s crucial to research what’s available in your area and understand the requirements.
Other ADU Financing Considerations
There is more to ADu financing than just knowing the basic types of finance options.
Let’s take a closer look at some specific questions we get asked regularly about the ADU finance and build process.
Can I use a traditional mortgage to finance my ADU?
It’s possible to use a traditional mortgage for ADU financing, but it’s not always straightforward.
Some lenders offer mortgage products specifically designed for ADUs, which may be easier to navigate. It’s important to consult with your lender to understand the best options available to you.
How long does it take to finance and build an ADU?
The timeline for financing and building an ADU varies a LOT. You need to consider your financing method and getting this approved, as well as the inevitable delays with construction.
On average, securing financing takes a few months (but can be faster depending on your connections), while construction can range from 9-18 months. These can vary a lot though.
Are there any tax benefits to building an ADU?
Depending on where you live, there may be tax incentives available for building an ADU.
There are also tax incentives and expenses you can deduct to make the process more tax-efficient – read our guide here for more info.
With anything like this, speaking to a tax specialist is the best course of action.
Important Considerations
When planning to finance an ADU, there are several critical factors to keep in mind. First, consider how an ADU will impact your property’s overall value. While ADUs can increase property value, it’s essential to ensure that the construction cost aligns with the potential return on investment.
Next, thoroughly research local zoning laws and permitting requirements, including any new laws that may have been introduced.
Additionally, factor in the total cost of construction, which can range from $100,000 to $250,000 or more, depending on the size and complexity of the unit. There are ways to keep the cost down, which you can learn about here.
Keep your long-term financial goals in mind.
No matter how you intend to use your ADU, it’s important that it aligns with your goals from a financial point of view. If the goal is to generate an income, you need to calculate the potential return vs the cost of financing the build.
Wrapping It Up
Don’t worry if you feel overwhelmed with the choice of ADU finance options.The best thing you can do is go through each option carefully and see which one is most suited for your current situation and long term goals.
In the end, ADU financing is not just about funding a project; it’s about making a strategic investment in your property and your future.