Modular Financing

How to Finance an ADU

Al Harris
November 24, 2021

Among all the other considerations necessary before building an accessory dwelling unit (ADU) on your property, financing the planning, permits, and construction tops the list. Even if everything else works smoothly, you cannot move forward without money. As more California residential property owners look to add ADUs, the options have expanded to meet the need.

If your house or property is big enough, you can make money off the empty space by building a backyard ADU unit. Adding one can represent a great way to pay off your mortgage sooner with rental income or realize bigger profits when you sell your home down the road. Regulations, zoning rules, and fees have gone down considerably with 2021 CA changes regarding ADU construction. If you want to take advantage of these changes, act now. The following four financing options can set you on the road to a satisfactorily completed construction project.

Self-Funding, Savings Accounts, and Credit for an ADU Unit

Any home or property renovation or construction project expense can come directly from your savings account, existing credit availability, or investment funds. Of course, paying for everything yourself upfront makes a lot of sense for overall savings as you will not have to pay interest on loans or additional mortgage expenses. It can also cut two other expenses like application fees, credit check costs, and charges from financial guides.

Paying cash upfront remains the most common way to fund an ADU construction project. However, this is an accessible for many families and may limit the design or size of the unit considerably. Whether you need a granny flat for an increasing multi-generational family for have the intention of renting out a tiny home in your backyard, the investment you make must be weighed against the outcome.

Home Equity Loans and Lines of Credit

The most common way to pay for an ADU is through taking out a home equity loan or through a home equity line of credit (HELOC). As long as you have sufficient equity, you can either get a set amount of cash or a revolving credit line to pay for every part of the addition. The former provides everything you need upfront and structured monthly payments for a longer period of time. The latter provides money only when you need it and charges interest on those amounts only. Research contract terms, interest rates, and repayment schedules before signing off on either of these funding options.

Mortgage or Cash-Out Refinancing

In some cases, refinancing your mortgage or getting a second mortgage can provide enough cash on hand to pay for permits, planning, materials, and labor for the ADU. Getting a lower interest rate months or even a year before construction starts can give you enough time to save up to pay in cash. If your property value has increased considerably since you got your mortgage, cash-out refinancing is another option. This pays you the difference between appraisals and reconfigures your mortgage for a different owed principal value.

Peer-to-Peer Lending Possibilities

Traditional lending options based on property equity and your own credit score make a lot of sense when it comes to financing and ADU. However, the growing popularity of peer-to-peer lending on the Internet may offer another option for some individuals. These platforms match people interested in investing in real estate with property owners who need money to expand or add another unit. Although different business models exist, they generally include the transfer of equity to the person putting up the money, which will go to them when it is sold or in certain other circumstances.

Another unique option is growing in popularity in recent years: AirBnB funding and loans. These are specifically intended to help you build the type of addition or prefab ADU you can use for short-term rentals. When figuring out what is an ADU for your own purposes, consider all possibilities that help you earn an occasional or regular income with the extra unit.

Approach Lenders With Full Plans and Goals

No matter what type of organization or individual you look to for ADU unit financing, you must begin the process with plans and goals firmly defined. It is not the time to embellish your savings, credit scores, income, or future development plans. While you will not have a construction plan in place at, as you need the funding first, create a report of things like estimated square footage, permit needs, overall timeline, and potential building companies to consider. Also, gather documentation that gives an accurate and complete view of your personal finance including income, mortgage costs, other debt, lines of credit, savings, and investments. All of this will help lenders make a quicker and more informed decision about whether they are going to give you money for your backyard ADU or not.

Adding a tiny home, granny flat, guesthouse, or any other type of ADU unit to your property requires a considerable financial investment. If you are not able to fund it with savings or simple credit, there are other options available. Leverage your home equity, refinance your mortgage, or investigate direct lending possibilities to increase the value of your residential property considerably.

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