Financing a granny flat or ADU on your property has never been easier. State and local governments continue to offer home equity financing incentives to expand housing across the U.S. Do you have an older family member living in your home? You may want to have them move into another building on your property, which is known as an accessory dwelling unit or ADU. Some simply call the ADU, a mother-in-law unit.
Building a second dwelling on your property can be a fine way to add separate space so your in-law or other family member has their own living area outside but close to your home. So, adding another dwelling on your property sounds great. But how will you pay for it? You have several realistic options for funding outlined below.
HELOCs and Home Equity Financing for an ADU
The most popular financing method for ADUs is an equity loan or home equity line of credit. You can tap some of the equity in your home to build or make improvements in a second dwelling on your property.
Spending your equity on the second dwelling is usually a wise move because you are adding value to your property by adding another livable dwelling. Home equity financing uses your house as collateral, offering competitive interest rates. You can use the borrowed funds to finance the construction of your ADU.
You can choose from two types of second mortgages: a home equity financing that provides you with a lump sum of cash with a fixed schedule for repayment; and a HELOC, which is a revolving credit line with shorter payment terms and (usually) a variable interest rate.
Both types are a good choice to pay for your second dwelling. Some homeowners may prefer getting all the money at once with fixed payment terms. But others like the flexibility of a HELOC with the lower interest rate in the first few years.
How to Finance an ADU
Accessory Dwelling Units (ADUs) have become an increasingly popular option for homeowners looking to maximize their property’s potential. These self-contained living spaces, often referred to as in-law suites, granny flats, or backyard cottages, can serve a variety of purposes, from providing additional rental income to accommodating extended family members. However, financing the construction of an ADU can be a significant consideration.
Here are some options to help you finance your ADU project:
Cash-Out Refinance Programs
A cash-out refinance lets you refinance your mortgage to a lower rate and give you a lump sum of cash that you will repay over time on top of your mortgage payment.
This is an appealing option for homeowners who want to switch mortgage companies, snag a lower interest rate, or combine the expenses of the second dwelling construction into a current home loan.
If you opt for a cash-out refinance, your lender will look at the value of the home along with the principal left on the mortgage. If the property rose in value since you purchase it, you may be able to do a refinance for the current value and get cash according to the new equity balance. The difference between the new loan amount and your existing mortgage balance is provided to you in cash, which you can then use for your ADU project.
A construction or renovation loan can be a good option to finance your ADU. This is especially true for homeowners who lack equity in the home to do a cash-out refinance or second mortgage.
Adding a dwelling unit increases the value of your property, so the lender will have the appraiser compare the potential value of the home once you have the second dwelling built, compared to the current value.
You can secure a construction loan to cover the building costs of your ADU. After the construction is complete, you may choose to pay off the construction loan with another type of financing, such as a mortgage.
Personal Line of Credit
Obtaining a personal line of credit can be a fine option for people who don’t have enough equity to qualify for a home loan that is secured by the home.
A personal line of credit has large as what you can get with a second mortgage. Also, there will be a higher interest rate, but it can be the way to go to build your ADU when traditional mortgage financing isn’t an option. While not the most common choice for financing an ADU, personal loans or credit cards can be used in a pinch. However, they often come with higher interest rates compared to the options mentioned above and may not be the most cost-effective way to finance your ADU.
CDFI Loan Program for Renting Out the ADU
A Community Development Financial Institution loan has plenty of flexibility for people who want to build an ADU on their property. These loans let the potential income from an unbuilt second dwelling to count as income for the loan. This type of financing is a good fit if you plan to rent the unit. If you’re building an ADU with the intention of generating rental income, the income from the ADU itself can contribute to its financing. The rental income can cover construction loan payments or provide a source of income that helps with other financial needs.
Some ADU companies have programs that may make building their units on your property more affordable. Some options include rent-share and in-house financing. Rent-share options have been used to great success by major companies such as Dweller.
These companies can install your prefab unit with no expenses for the homeowner. After the building is finished, the homeowner can purchase the unit back at a fair price.
Before choosing a financing method for your ADU, consider your financial situation, long-term goals, and the overall cost of borrowing. Each option has its advantages and drawbacks, so it’s important to assess your needs and make an informed decision to ensure the successful completion of your ADU project.