Financing options for ADU construction
More and more home owners are intrigued to the concept of adding an ADU to their property, whether it’s to house family or rent it out for passive income.
ADU construction benefits homeowners personally as well as aids in the fight against the housing crisis, particularly in California.
However, the absence of ADU financing options meant that many homeowners up until recently were unable to make this notion a reality.
Fortunately, the rising demand for ADUs has increased the number of funding options available to homeowners.
In order to assist you choose the best course of action, we are here to walk you through ADU financing.
ADU Budgeting
Let’s look at the price of building an ADU before we examine some of the financing possibilities for ADUs.
The median statewide construction cost for an ADU in California is $150,000, or $250 per square foot, according to a recent research from the Terner Center for Housing Innovation.
Nevertheless, there are noticeable pricing differences based on the county, unit type, and ADU’s number of bedrooms.
For instance, the anticipated cost to create a separate apartment is $180,000, whereas garage conversions cost about $90,000.
Additionally, ADUs with two bedrooms typically cost around $200,000. Studios are projected to cost $100,000.
ADU Loans and Financing Options
A lot of the financing possibilities for ADUs are determined by the equity you have in your primary residence, your household’s income, and your credit rating.
The problem with these conventional choices is that there is frequently a discrepancy between the cost of building an ADU and the homeowner’s ability to borrow money.
Fortunately, there are certain options that allow you to obtain a loan based on the potential value of your house. The Fannie Mae Homestyle Renovation loan is one example of a loan for renovations where this is the case.
Think about how your ADU will be used in the future before choosing this choice.
For instance, renting out your ADU can assist you in making the ADU loan payment or provide a profit.
According to the Terner Center’s assessment, a new ADU in California that can accommodate a family of two costs between $1900 and $2300 per month to rent.
Let’s look at 5 financing choices you should think about when developing your ADU keeping everything in mind.
1. Cash-out Refinancing
You can convert the equity in your house into cash with a cash-out refinance. You can achieve this by obtaining a new mortgage with a greater loan balance than the one you already have.
This will allow you to combine your regular mortgage and ADU financing into one loan, allowing you to pay off your first mortgage and use the remaining money to finance your ADU.
In light of this, if you have accumulated equity in your house, cash-out refinancing is a sensible choice.
You’ll need to have about $200k built up in home equity given the average ADU prices.
But bear in mind that:
With most cash-out refinances, you can only withdraw 80–90% of your equity as cash;
When refinancing with a cash-out loan, you must modify your primary mortgage’s interest rate to one that is probably higher.
2. Unsecured Loans
Unsecured loans, or personal loans, are not backed by any collateral like property; instead, they are determined by the borrower’s creditworthiness.
Your assets are not at danger when you take out an unsecured loan to pay for your ADU, which is one advantage. The application procedure is also lot simpler, which is a benefit.
These loans typically feature higher rates and payments and a lesser amount you can borrow because they are riskier for the lender.
For instance, LightStream provides financing for tiny houses, and their loans have an interest rate minimum of 4,99% and a range of $5,000 to $100,000.
Therefore, an unsecured loan can be a smart option for you if you’re going for a simpler ADU project, such as a garage conversion or a studio.
3. Home Equity Loans and Lines of Credit (HELOCs)
A second mortgage, such as a one-time loan or a home equity line of credit (HELOC), can also be obtained to use your home equity to finance your ADU.
You can obtain a lump sum from a home equity loan that you must repay in a set number of installments.
HELOCs are a little unique. They give you the option to borrow money as needed with a variable interest rate, much like credit cards.
Home equity loans don’t replace your present mortgage, in contrast to cash-out refinance loans. Many homeowners like it since it guarantees that the initial mortgage’s terms and interest rate won’t change.
In actuality, 56% of Californian homeowners who constructed ADUs did so with the help of a home equity loan or HELOC, according to the Terner Center’s analysis.
4. Construction or Renovation Loans
Equity loans designed exclusively for renovation projects include construction and renovation loans.
The key advantage of these loans is that they let you borrow money based on the worth of your house in the future when the renovation (in this case, the building of the ADU) is finished.
For instance, Renofi will permit you to borrow up to 90% of the value of the home after renovations and up to 125% of the present home value.
Cash-out refinance loans, on the other hand, only permit you to borrow money up to the current worth of your house.
Due of the possibility of receiving big amounts, many homeowners opt for the Fannie Mae Homestyle remodeling loan for their ADU projects.
They may now borrow more money to pay the $150–$200k cost of an ADU thanks to this.
There are drawbacks to these loans, though. The administrative formalities are difficult for many homeowners to understand, which prolongs the closing process.
They also have a high refusal rate (45% of applications are rejected versus 18.4% of cash-out refinancing customers), which is a problem.
5. ADU Home Equity Share Investments
An option to taking out a loan is to use a home equity share agreement to access your equity. The concept is that an investor will loan you up to $500,000 to utilize on your ADU in exchange for a portion of any future property appreciation.
Therefore, this can be the ADU financing option for you if you don’t qualify for any of the loans mentioned above or if you simply don’t want to increase your monthly spending.
This financing choice is predicated on the belief that any property’s worth will probably increase in the future. Therefore, it does not rely on conventional criteria like credit scores or DTIs.
Are you unsure if this is the best choice for you? To map out various scenarios or see what some of the top home equity investment lenders are providing, utilize our ADU Equity Share calculator.
What Does ADU Mean For Finance?
In finance, ADU stands for accessory dwelling unit. It refers to a secondary living unit on a property, frequently a separate building or a space that has been transformed, that can be used to house family members, generate additional rental income, or serve as an investment property. ADUs are becoming more well-liked in the financial world as a way to boost property value and give homeowners a boost in income.
How May an ADU be Built in California?
In California, there are various financing options available for ADU construction. Traditional options for financing a home purchase include personal savings, home equity loans, and refinancing an existing mortgage. It is also possible to apply for grants, low-interest loans, or special ADU funding programs offered by nonprofit groups or local governmental bodies. In order to finance the development of an ADU, some homeowners might also take into account private lenders or partnerships.
What is the Price of an ADU?
ADU construction costs can vary significantly depending on location, size, design, material costs, and labor rates. Construction of an ADU typically costs $100,000 to $300,000 or more in California. Costs may be lower for smaller, simpler ADUs, whereas larger or custom-designed units may be more expensive. Before starting the construction, homeowners must get specific bids from contractors and take into account all connected costs.
How is ROI Determined for ADU?
An ADU’s ROI, or Return on expenditure, is determined by comparing the net profit the ADU generates over a predetermined time period to the initial expenditure made to build it. The total money produced by the ADU (such as rental income) must be subtracted from all construction, financing, and ongoing maintenance expenditures in order to determine ROI. The net profit is then multiplied by the initial investment and expressed as a percentage by multiplying by 100. A positive ROI shows that the ADU is making money beyond its expenses, making it a sound investment.
