ADU Guide

How Do I Finance My ADU?

Building an ADU is a big financial commitment. What are the options for paying for my new backyard Cottage?

Caleb LeeMay 18, 2021

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. While we can't give you financial advice in this article, we hope to illuminate the various ADU financing options available in 2021 for you to choose from.

Ready to embark on your ADU journey or just want to learn more? Click on the "Get Started" button on the top righthand corner of this page to talk to Cottage's ADU experts today!

Cash or Savings

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, 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.

Home Equity Loans

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 own the property 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 shorter repayment terms. 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.

Cash-Out Refinance

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 value of your home.

Construction or Renovation Loan

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 over time based on project milestones that are verified by the lender or a third-party inspection service.

Construction / 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, but it does provide an additional ADU financing option in cases where traditional loans are unavailable.

Personal Credit Line(s)

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 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.

Local Partnership Loan Programs & Grants

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, with his May 2021 budget proposal including $81 million dollars in proposed federal funding to expand the state's ADU program.

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.

What ADU Financing is right for me?

Regardless of the financing path you choose for your ADU, determining the best option takes time and often discussion with spouses, partners, and other family members or decision-makers. 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 ADU. We believe in providing you with a tailored, up front cost estimate before you commit financially to your ADU project so that you know how much you ADU will cost before proceeding into permitting and construction.

Now that you know what your ADU financing options as well as what goes into the hard costs and soft costs for your ADU, click the "Get Started" button below to get a Free Consultation and Estimate Today!

Get your free consultation and estimate today!