ADU FINANCING
How to Finance an ADU in San Diego
Financing an ADU project in California involves understanding your loan options, estimating project costs, and ensuring your financing plan covers the full scope of construction. Whether you’re building an ADU to generate rental income or accommodate family, ADU financing requires more than just finding the right loan. Moreover, it’s about ensuring your loan aligns with the actual all-in costs of the build.
As an ADU design build company, we often see homeowners blindsided by unexpected expenses that weren’t accounted for in their initial plans. For this reason, it’s critical to have a clear, all-in budget when securing financing. Furthermore, you don’t want to lock in a loan only to realize later that the funds fall short of covering essential ADU costs like site work, permits, or utility connections.
To assist with this, this guide is designed from a builder’s perspective to help you navigate the ADU financing process. Specifically, we’ll walk you through how to plan your budget for a successful ADU build, various financing options, the steps to secure an ADU loan, plus top FAQs. By understanding the true scope of your project and ensuring your loan matches your financial needs, you can avoid surprises and ensure a smooth ADU build from start to finish.
Budgeting for an ADU Project
Careful budgeting is a critical aspect of any ADU project. All costs should be accounted for, ensuring no surprises during construction. Understanding the full scope of costs involved, such as sitework, utility connections, construction, finishes, design and permitting, will allow you to align your vision with your financial capacity.
Your ADU design should match your budget, not the other way around. Ensure you’re discussing budget constraints early in the design phase to avoid costly changes later on.
Start with a rough estimate of how much your ADU will cost, including both the construction and pre-development expenses like architectural designs, permits, and site preparation. This early estimate will serve as the foundation for your financing discussions. Then, refine the estimate through the Feasibility process, where your ADU builder will carefully assess all the hidden costs that could apply to your project.
Understand ADU Costs
Understanding the costs associated with building an accessory dwelling unit is essential for making informed decisions about your investment. From initial design fees and permits to utilities, materials, and labor, each component contributes to the total price tag of your ADU project. By exploring the various factors that influence ADU costs, you can better evaluate your options and align your budget & ADU financing with your vision.
ADU Plans and Pricing
Check out our ADU floor plans for full pricing estimates on each model, or consider going for a custom ADU. We’re big on transparency and want you to be prepared with the expected all-in cost for building your accessory dwelling unit so you can secure the right ADU financing as needed. It’s never too early to bring us in to the conversation for a free consultation as you think through options.
Lower Cost ADU: Consider Partial DIY
Taking charge of the finishing touches in your ADU project can be a rewarding way to personalize your space while enjoying significant cost savings. After we complete the drywall, the canvas is yours to finish. Self-managing the completion of the ADU can allow you to save and keep your budget in check with your finances.
Best ADU Financing Options
Below are the most typical loan options we see homeowners using for their ADU projects.
Home Equity Loan
A home equity loan (related to a home equity line of credit or HELOC) is typically the simplest way to finance an ADU, though expect rates to be higher like everything else right now. Primary residences can typically have up to 80-90% Loan-To-Value (“LTV”). So if your home is appraised at $700K and your current loan is only $400K, you could expect to access a credit line of $160K (80%*$700K= $560K-400K). A home equity loan often allows for flexibility, as you can draw down the credit line as you need the funds – you are only charged interest on the amount of credit used.
Fixed Rate Second Position Loan
Interested in keeping your existing loan rate? A newer loan product available is based on the value of your home after you add the ADU (“after renovation value”). No refinancing of your existing loan is required and terms are up to 20 years, plus there are no “draws” like a construction loan. You receive the entire loan amount upfront. After the renovation is completed, the appraiser visits the home to issue a certificate of completion. Read more about fixed rate second position loan options.
Construction Loan
If you don’t have much equity in your home, a construction loan could be a good option for ADU financing. The construction loan will cover the building costs and then once construction is completed, the construction loan rolls into an adjustable rate mortgage (ARM), which means it is a refinance of your original mortgage. Loans typically have interest-only payments during construction with no interest due until the line is actually drawn down once the project starts. These loans are available for owner-occupied properties and rental properties alike.
Renovation Loan (203K or Homestyle)
Renovation loans allow homeowners to finance a renovation project (including ADUs) into the mortgage. Fannie Mae Homestyle allows for construction of detached ADUs. The loan has a conforming limit of $977,500 and may be based on the “future value” of the property after adding the ADU, which will be based on appraisals (not rental income). Renovation loans typically offer up to 95% financing of a primary residence or 85% of an investment property. Renovation loans can also be packaged with a loan for the purchase of a property.
Cash-Out Refinance
A cash-out refinance replaces your existing mortgage with a new home loan for more than you currently owe on your house. The difference goes to you in cash that can be used on guest house construction or other renovation. You must have equity built up in your house to use a cash-out refinance. Limits are typically at 80-90% of your home’s equity. So if your home is worth $1M and you currently owe $600K… you could likely get a loan of up to $800-900K for a cash-out opportunity of $200-300K.
Home Equity Conversion Mortgage (HECM, ages 62+)
Also known as a reverse mortgage, an HECM is possible when at least one of the owners is 62 or older and the property is a primary residence. Owner can borrow up to 42% of home at age 62, all the way up to 70% at age 86 or older. Any existing loan would need to be paid off with the new one, and remaining money from the new loan can be used on the primary residence or on an investment property. The loan is structured as a line of credit and the borrower has access to the line with no fund control requirements (e.g. no construction draws required).
Portfolio Lending
If you’re an investor looking to add ADUs to your property, new loan products are becoming available. One exclusive option for SnapADU customers is a bridge loan designed specifically for investment properties. The ADU construction 2nd lien loan offers a unique advantage: it’s not capped based on your existing equity.
While the double digit interest rate and origination fee make it a more expensive option, this bridge loan is designed for short-term use. The strategy is to refinance immediately after the ADU construction is complete with a traditional loan product.
Second Position Bridge Loan Details
- Max Loan-to-Cost (LTC): 80%
- Term: 12 months, with a 3-month extension option
- Payments: Interest-only payments
- Origination Fee: 2% of the loan amount (minimum $10,000)
- Funding Requirements: Permits must be in-hand before the loan is funded
- Personal Guaranty: Required, with a minimum FICO score of 720
Please keep in mind that loan terms and availability may vary based on lender policies and individual qualifications. SnapADU is not a licensed financial advisor or lender, but we are happy to connect you with our trusted lending partners to help you find the right financing solution for your ADU project. Contact us.
How Can I Compare ADU Loan Options?
Looking for ADU loans in San Diego? Use our ADU financing calculator to look at several different loan options, including Renovation Loans, HELOCs, and Cash-Out Refinance. You can include the estimated costs for your ADU that are based on our actual plans and prices. We want to help you get the numbers you need to make an informed decision on building and financing your ADU in California. If you don’t already have a lender, we are happy to put you in touch with experienced preferred providers we regularly work with on granny flat financing.
Steps to Securing an ADU Loan
When seeking financing for your ADU project, it’s essential to understand the loan process, from application to approval. The steps outlined below will guide you through securing an ADU loan, ensuring that you have all the necessary documentation and meet lender requirements.
1. Assess Your Financial Situation
Before applying for an ADU loan, take stock of your financial situation. First, check your credit score, gather income verification documents, and consult a financial advisor if needed. Understanding your financial health will help you know your borrowing potential. You can then identify any improvements you should make before applying. This will also help you anticipate the loan programs you qualify for.
Additionally, if your family is helping pay for the ADU, you may want to read our ADU Guide for Families for important considerations regarding title.
2. Get Ballpark Costs for your ADU Project
Early in the process, consult with an experienced ADU contractor to get a rough estimate of how much your project will cost. This will give you an idea of the budget you’ll need, without diving into specific design details yet. Remember, your goal at this stage is to determine how much you can borrow or pay. By getting a general cost estimate, you can better align your design with your budget.
3. Get Referrals and Explore Options
Get ADU lender referrals from trusted sources, such as financial advisors, contractors, or fellow homeowners who have successfully built ADUs. They can guide you to reputable lenders and help you avoid pitfalls. For non-owner occupied properties, you can also explore private money lending options. This includes bridge loans, which don’t require equity and are based purely on the total project cost. Some of these loans offer flexibility that traditional lenders don’t provide. Contact us here to learn more about private loan options for your ADU project.
4. Choose the Right ADU Loan Program
Next, research various ADU loan programs to find the best fit for your needs. These may include construction loans, home equity loans, and renovation loans. Evaluate factors such as interest rates, loan terms, and potential application fees. SnapADU focuses on building your ADU, so we recommend that you talk to several lenders to compare your options.
5. Prepare Your Preliminary Loan Application
At this stage, compile the necessary documentation for your loan application. Typically, this includes income verification, credit score details, and other financial records. Early in the application process, the focus is on verifying your financial eligibility. Specifics about the ADU project will be vetted later, so ensuring you have these personal financial documents in order is essential.
6. Kick off ADU Design & Feasibility
Once you’ve received initial financing approval, it’s time to begin your ADU feasibility study and design process. Select a licensed builder with ADU experience, as lenders will require contractor information and project specifics to proceed. A Feasibility Study will assess the viability of your project, providing detailed construction costs and scope of work needed for the loan. Additionally, it’s the first phase towards obtaining your construction permits. Lean more about finding the right ADU company.
7. Appraisal and Loan Approval
As your project moves closer to the permitting stage, your loan details will be finalized. For construction loans, the lender will typically order an appraisal to estimate the future value of your property with the completed ADU. Based on our experience, submitting key documents like a floor plan, elevations, a detailed scope of work, construction budget and payment timeline is sufficient for this step. Then, if the appraisal aligns with the lender’s expectations and your financial documentation is in order, the loan will be approved, and the next steps for funding will be outlined.
8. Loan Disbursement and Monitoring
Finally, once the loan is approved, funds will be disbursed according to your loan program. For HELOCs, funds may be released in one lump sum, while construction loans are typically distributed in stages, known as draws. These draws are tied to construction progress milestones. Lenders may require inspections to verify that the work is being completed as planned, releasing funds at each stage to ensure the project remains on track.
ADU Financing FAQs
Can the future value of the property after adding an ADU be used to qualify for a higher loan value?
Yes, this is possible. The Fannie Mae Homestyle Conventional Renovation loan program can be used for purchase of a property and construction of a detached ADU. The loan amount may be based on the future value of the home, i.e. after adding the ADU. The max loan amount is $1,006,250 (Fannie Mae limit for 2024 for San Diego area). Investment properties can be up to 85% financed, while primary residences may be up to 97% financed.
Here’s an example of “maxing out” that loan potential while building an ADU:
- To max out the loan value, we’d be looking for a property with a future value of $1,183,823 (=$1,006,250/85%) for an investment property… you could go over the limit, but would have to put in more cash
- Let’s say you choose an ADU that has all-in costs of ~$400K
- That leaves about $784K for the purchase of the property (=$1.18M-$0.4M), if the investor didn’t want to pay for any construction costs out of pocket
- The investor would be responsible for a down payment of ~$177K (=15%*$1.15M)
Can the potential income of an ADU be used to qualify for a higher loan value?
Yes, this is possible. As of October 2023, the Federal Housing Administration (FHA) announced lenders can now include income from ADUs when underwriting a mortgage.
- For properties with an existing ADU: up to 75% of estimated ADU rental income can be counted for borrowers qualifying for an FHA-insured mortgage.
- For adding a new ADU through construction: 50% of the projected rental income can be included under FHA’s 203(k) Rehabilitation Mortgage Insurance program.
This opens up additional avenues for financing and makes ADUs an even more attractive investment. As of November 2022, Freddie Mac is offering a program for 1-3 unit properties. This makes it possible to purchase or refinance (for instance, out of a construction loan) while factoring in the rental income from the ADU towards the value of the property. There is no seasoning period required for refinancing, meaning you can initiate the financing as soon as you have a rental contract signed for the ADU.
Does SnapADU work with construction financing?
Yes, we work with you and your lender to ensure you have the required plans, scope of work, and budget required to submit for loan documentation to get approval for a construction loan.
Once the project is started, we will also handle the coordination of the loan documents with the lender, including managing inspections and “draws” during construction. Draws are payments by your lender that are tied to construction progress milestones. Your construction loan balance will increase as the bank releases the loan funds to your contractor to pay for work completed this far. This means that you don’t typically pay interest on the entire amount of the loan upfront, but only on the portion “drawn down” thus far.
How much detail do I need to provide to my lender for construction financing on an ADU?
To secure construction financing for an ADU, your lender will require certain documentation, including your intended floor plan, elevations, scope of work, and a detailed budget specifying the total construction costs. Fortunately, all of this information is provided in SnapADU’s Feasibility Study, which includes everything needed to start the financing process. These details give your lender an overview of the project and help them evaluate its cost-effectiveness.
How do I make sure I have enough financing for my ADU project?
It’s crucial to ensure your financing covers the entire scope of your ADU project. After completing a Feasibility Study, SnapADU offers a Price Lock Guarantee, which means your price won’t unexpectedly increase after you’ve secured financing. This ensures that once your loan is approved, you’ll have the budget in place to complete the project without worrying about rising costs.
What is the CALHFA ADU grant program?
As part of an initiative to create more affordable housing, California introduced the CalHFA ADU Grant Program, which provided up to $40,000 to homeowners to help cover pre-development costs of ADU construction. These grants were designed to help offset expenses like site preparation, architectural designs, permits, soil tests, and impact fees, making it more affordable for homeowners to build ADUs and contribute to easing the housing crisis.
The End of CalHFA ADU Grant Funding
As of December 28, 2023, the CalHFA ADU Grant Program has officially exhausted its funds. The latest round of funding was fully allocated, and no additional grants will be available moving forward. This program has successfully contributed to the creation of many ADUs across California, helping increase housing availability.
What Now? Alternatives to the California ADU Grants
While the CalHFA ADU Grant Program has ended, there are still financing options available for those looking to build an ADU. Additionally, some local jurisdictions offer fee waivers. Read more about ADU fees & waivers.