Financing Your Accessory Dwelling Unit
Accessory Dwelling Units, or ADU’s, can be a fantastic solution to providing living quarters for aging parents or adult children transitioning to the next stage of their life, as a way of generating some extra income as a rental unit, or even to simply add an extra work or play space. As with any sort of renovation, remodel, or construction, the cost can be substantial and proper financial planning is the key to ensuring a timely and properly-budgeted project. Whatever the reason for building an ADU, there are several considerations to take into account that will dramatically affect the scope and cost of the project.
Would you like to add an ADU to a property you currently own or are interested in purchasing? Will the ADU be an existing space, such as a garage, that will be appropriated and renovated? Will it be an entirely new structure or will the ADU be attached to the primary structure? Is the ADU going to be rented long-term, as an Airbnb-style vacation rental, or completely for personal use?
Types of finance:
While many people would hope to have the money for the project on-hand, this is simply not the reality for most homeowners. Even without having the cash on-hand, there are several compelling financial options to help you realize your ADU dreams. Financing options run the gamut from loans from family to Home Equity Lines of Credit to special federal loans for home improvement and renovation. Options include:
Savings and Liquid Assets/”family-loans”:
The easiest way to finance an ADU is with personal savings. Perhaps you have a retirement savings plan against which you can borrow cash or stocks which can be sold to generate the capital needed for the project. Others may have family or friends who are willing to loan money at a low interest rate. Even a 3% interest “family-loan” is cheap for the borrower and a low-risk investment loan may be more appealing to your endowed elders than you might think. 203(k) Loans:
These loans are borrowed against the future value of your home after renovations and will allow you to roll the costs of your renovation into your mortgage. They can be used when purchasing a new home or refinancing a current home as long as the home will be considered your primary residence. Both loan types require your contractor to provide a reasonable six month schedule that they will need to stick to in order to receive payments. This ensures timely completion of your renovation. 203(k) loans come in two shapes and sizes, the Standard 203(k) and the Limited 203(k). Standard 203(k) loans are considerably more complicated in terms of documentation and planning than Limited 203(k)s and require at least $5,000 in renovations, but can provide up to hundreds of thousands of dollars in renovation money. A Limited 203(k) loan has no minimum renovation cost but is capped at $35,000 and is not allowed to be put towards any structural improvements.
Home Equity Loans/Lines of credit:
If you already have substantial equity in an existing home (>20%), taking out a Home Equity Loan or a Home Equity Line of Credit can be a compelling option with rates as low as 3.75%. Fewer requirements/restrictions and an easier process means less time and fewer headaches involved in acquiring the capital to complete an ADU. A proper estimate of the future value of the home and a trustworthy general contractor is necessary to ensure that this option makes sense.
Stated Income Loan Program:
Stated Income Loans are no longer available for owner-occupied homes, but they are available for investment properties as they are considered business loans. If you plan on adding an ADU to a property that you do not live in, this loan may be for you. For borrowers with very good credit ratings and the ability to put 30% or more down for an investment property, this financing option allows for property flippers to take on a project without having to finance it completely out of their own pocket. These loans generally come with higher interest rates, so it’s only advisable for shorter-term investors or for investors who need to buy another rental property to better their cash flow.
These loans are for new-built homes and often require extensive banking history due to the lack of collateral (a finished home). Down payments are generally around 20% and these loans have a maximum 12 month term. Rates are higher than on permanent mortgage loans but often the lender will accept interest only payments during construction. Lenders require detailed construction timetables, plans, and a realistic budget. Upon completion of the home, the borrower’s loan liability will typically roll over into a mortgage. Already owning the land on which the house is built can help to serve as equity.
New Avenue Homes:
If you already have a tenant in mind that can prove that they can afford rent payments, New Avenue will handle the building and permitting process for no upfront cost to the homeowner. The company uses professionals across the country to design, permit, and build ADU’s while accepting payment from the tenant with any rent above the cost going to the homeowner.
Starting your ADU journey:
Realistically evaluating your situation and exploring your financing options will determine the viability of the project. As with any financial decision, a cost benefit analysis is necessary to decide whether building an ADU is right for you. Having a concrete goal in mind (i.e. rental income, flip, or personal use) at the outset of this process is important so that a plan can be tailored to your situation.