ADU Financing

Previously, we covered all the soft costs and hard costs of accessory dwelling unit (ADU) construction. Now that you're ready to proceed with your project, the next big step is securing the funds necessary to build your new backyard unit from the ground up. Here are ADU financing options available to you.

In terms of ease and speed of access, cash or savings on hand or other liquid assets such as stocks are at the top of the list. Many homeowners with Cottage have saved for their ADU project or a similar renovation project for some time, giving them the immediate flexibility for paying for the cost of their ADU. ADU projects can come in many different shapes and sizes like basement apartments in single-family homes, backyard homes in a duplex, or garage conversions in your primary residence, and it is important to be financially prepared for the significant yet rewarding investment.

Because Cottage only requires payment when specific design, permit, and construction milestones are hit and your ADU is on its way to being built, you do not necessarily have to have all the funds readily at hand to proceed with your ADU process. However, it is important to have a financing plan in hand, especially if you do not have the entire amount for your ADU readily available. Homeowners often combine their savings with other loan options to finance the total cost of their ADU or pursue a loan to cover the entire cost of the ADU project—let's take a look at some of those options on the market today.

Also known as second mortgages, Home Equity Loans are one of the most common financing methods that we have seen homeowners use to finance the building of their custom ADU. If you own a significant portion of your home—or have paid off your first mortgage and own the residence outright—this may be a good option for you.

These home equity loans allow you to leverage the pre-existing value of the home against the future home improvements that you plan to make on the property that will then increase the overall value of the home in the future. In this case, the home improvement comes in the form of your new custom ADU, which increases the property value through added square footage, additional bedrooms / bathrooms, and a valuable potential stream of rental income.

There are two common types of Home Equity Loans: A classic Home Equity Loan sees the bank or financier give you a set amount of money and a fixed repayment schedule, while a Home Equity Line of Credit (HELOC) is a revolving line of credit with a variable rate and short-term repayment. Just as ADUs can be customized to your specific needs, the right Home Equity Loan option depends on your property and financial circumstances. Our recommendation is to speak with your existing mortgage provider to see what is right for you, or seeking out other providers that offer home equity loans to homeowners like you.

In low interest rate times, refinancing is a popular option for homeowners looking to lower their monthly interest payments for their mortgage. But did you know that you can use a Cash-Out Refinance to pull money out of your house's existing value to pay for your ADU project?

This form of Cash-Out Refinancing provides a one-time payment that you repay through your updated monthly mortgage payments in connection with the refinanced interest rate. Your lending provider will evaluate the present value of your home (either through direct appraisal or through a proxy such as a Zillow Zestimate) against the amount of principal remaining on your existing mortgage. And if the value of your home has increased, you may be able to refinance the home based on that present value, rather than based on the old valuation that the original mortgage financing terms was based on. This would allow you to "cash-out" based on the new equity balance, giving you the funds to pursue your ADU project and further increase the future value of the property.

In the case where you do not have enough existing home equity to qualify for a Home Equity Loan or Cash-Out refinance, you may be able to finance your ADU through a Construction or Renovation Loan. In this process, the loan provider evaluating your application will compare the projected value of your home with the renovation completed in the future (in this case, the new ADU) against the current value of the home without the addition of the ADU. The lender would then loan you the difference while charging a percentage fee as well, giving you parts of the loan amount over time based on project milestones that are verified by the lender or a third-party inspection service. You can also use a renovation loan to combine the cost of your ADU and a home purchase, if borrowers are interested in purchasing their family homes outright.

Construction Loans / Renovation Loans tend to have higher interest rates and may be a more onerous way to pursue your ADU financing because of the associated admin overhead that is required of the general contractor. Despite the high-interest rate, this does provide an additional ADU financing option in cases where traditional loans are unavailable.

Private money can also be a viable financial resource for homeowners, especially for those looking to use another property they already own as collateral or are simply looking for a lower-hassle loan. In addition, this could also be an option for homeowners who have been denied traditional financing or do not have access to those resources.

As opposed to bank lending, private money refers to financing that does not come from an institutional bank or loan provider. For example, this private funding can come from family members, via other assets you already own, or via private equity funds that are funded by accredited investors.

Because there is not a traditional financial institution involved, there tends to be more flexibility in approval standards and loan terms, though this of course depends on the lender and your personal financial situation. The downside and biggest risk to a private money loan is that the interest rates to be higher than a traditional loan, but that can vary as well.

Cottage is happy to discuss your options with you and recommend a potential path forward for funding your ADU unit project.

For situations where the homeowner either does not have enough equity in their existing home to qualify for a home equity loan or is only in need of a smaller amount for their ADU financing, a personal loan or Personal Credit Line can fill the gap between your current funds and the cost of your ADU project.

While this form of credit line typically comes with higher interest rates than a home equity loan or refinancing the existing home, they can be good last mile or last option solutions for financing your ADU.

With the introduction of an easier ADU planning and permitting process throughout much of California, local municipal and government financing partnerships have started to become available, with more on the way. At the state level, California Governor Gavin Newsom has been a strong proponent of ADU legislation and financing–in recent years, he has signed legislation and committed millions of dollars to expand the state's ADU program. What's more, CalHFA's ADU Grant Program was renewed in June 2023, and provides $40,000 to help homeowners cover the planning and permitting costs of their ADU project.

At the local level, some counties and cities have gone further to incentivize ADU construction. San Mateo County's "One Stop Shop Program" allocates support for ADU design, permits, and construction via a partnership with Hello Housing, while the City of San Jose's Accessory Dwelling Unit program provides pre-approved ADU designs as well as additional support for ADU construction. While efforts across the state are still in the early days, the California Department of Housing and Community Development continues to support local ADU partnerships and more initiatives are likely to follow.

Regardless of the financing path borrowers choose for their granny flats, determining the best option takes time and often discussion with spouses, partners, and other family members or decision-makers. This will also depend on factors such as income, credit score, existing debts, and location. A short-term loan in Los Angeles may look very different from a short-term loan in Fresno or the Bay and may have different loan limits. While certain financing options may make more sense for your specific situation, there is no one-size-fits-all approach to ADU financing in the same way that no prefab ADU fits all properties and families.

Cottage has experience advising homeowners like you in making the best decision possible for your new construction. We believe in providing you with a tailored, upfront cost estimate before you commit financially to your ADU project so that you know how much your ADU will cost before proceeding into permitting and construction.