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5 Ways to Finance an ADU

New California laws make investing in an ADU (otherwise known as a “secondary” or “in-law” unit) an amazing opportunity for some homeowners and home-buyers:

  • By building an ADU, seniors can remain on their own property while adding to their home’s value and gaining hundreds or even thousands of dollars of extra income each month.

  • Home-buyers can team up with a second household (typically friends or family) to buy a home they couldn’t otherwise afford, and build an ADU for one household to live in.

And these are just two strategies by which an ADU can improve Californians’ cash flow, financial security and quality of life.

That being said, financing an ADU can be tricky, and doing so is outside the area of expertise of the vast majority of loan officers and lenders, so if you’re considering an ADU build, it’s crucial you begin by working with a loan officer who’s versed in all the various ways to finance ADUs. Below is a list of five strategies for financing your ADU project. And if you’d like to determine which strategy would work best for your situation, call me for a free consult today.

1) Cash-Out Refinance (or HELOC, then Cash Out Refinance)

This is probably the most popular and straightforward method for financing an ADU. And so long as a homeowner has sufficient income and equity in their property, this way is most likely preferable. Unlike many loan officers and development/construction professionals though, I strongly advise that a home equity line of credit (HELOC) is not used as a permanent financing instrument with this method, because HELOCs have adjustable interest rates, they can result in payment shock when their repayment period begins, and as a result of the new tax code, mortgage interest is not tax deductable with HELOCs. HELOCs are fine for a temporary form of construction financing, but I recommend they be repaid by a cash out refinance of one’s first mortgage once the project is complete.

2) Renovation Mortgage

In certain circumstances where borrowers have sufficient income to repay the cost to build an ADU in addition to the cost of purchasing or refinancing the property in its current state, a conforming, renovation loan can be the best option. The two, conforming renovation loan programs available to borrowers are the FHA 203(k) and the Fannie Mae HomeStyle, and they are sometimes preferable because they allow borrowers to have less equity in the property than would be needed with a cash-out refinance. Also, this type of loan could work in purchase transactions where the intent is to build an ADU ASAP once the property is purchased, without having to do another loan transaction. There are a number of important limitations to these loans though, so a careful analysis of a borrower’s situation is a must before deciding to go with this program.

3) Construction, then Permanent Loan

While no lenders or brokers I know besides myself offer this strategy, it is the best option for borrowers who need to the rental income they’ll make in the future from renting their ADU to count towards qualifying for a loan to build it. This can be especially helpful for some seniors on a fixed income who intend on renting out their ADU, or moving into their custom ADU and renting out their main house. However, younger borrowers intending to rent their ADU or main house may use this method too if their income isn’t sufficient for the above options.

4) Reverse Mortgage

For borrowers age 62 and older, a reverse mortgage is often easier to qualify for than a standard, “forward” mortgage is. What’s more, while borrowers of reverse mortgages may choose to make monthly mortgage payments to reduce their loans’ balances and increase their home equity over time, these payments are optional. This repayment flexibility makes a reverse mortgage the preferred option for many seniors who don’t want to feel pressured to be consistently collecting rent and making mortgage payments each month, but who want to enhance their retirements through ADU rental income or through housing a loved one. And building an ADU with a reverse mortgage works even better as a wealth building strategy for seniors who intend to build a small ADU to move into it and rent out their larger house.

5) Hard or Private Money Loan

Private or hard money loans are at times the preferable way for investors to finance ADU construction at their (non-owner-occupied) investment properties. As the name “Hard Money” implies, these loans have higher costs in terms of upfront fees and interest rates than the other options, but the flexibility and speed with which some hard or private money lenders can approve these loans makes them worth it to investors. Rather than looking at an investor’s personal credit and income, these lenders look predominately at the amount of equity in the property and whether adding an ADU makes sense as an investment. However, prior to applying for a hard money loan, it’s imperative that an investor first verify that he or she can build an ADU at the property in question, because many cities and counties don’t allow ADUs to be built on non-owner-occupied properties.


Again, contact me today if you have any questions about financing the construction of an ADU or about ADU development in general. As a mortgage consultant with experience in all the above loan types and programs, and as the owner of New Equity Homes, a real estate development consultation company specializing in helping homeowners build ADUs, I’d be happy to provide you with free consultation to get your project started off on the right foot.

Last, if you’re seriously considering building an ADU, I strongly recommend we discuss your vision before you pay an architect for putting together drawings or a contractor for putting together construction estimates. Even if they’re ethical enough to care whether you have the funds to finish the project, these professionals won’t have a clue whether you’ll be able to finance your project, so take my advice, and begin with the financing like development pro would do.

Anthony Capitan

Mortgage Consultant

C2 Financial Corporation


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