How people actually pay for an ADU

An ADU is a big check for a small building, and most homeowners are not used to construction financing. The good news is that the federal mortgage agencies have opened up in the last few years. The less good news is that most real owners still pay mostly with their own money.

What owners actually used

In the statewide California owner survey, owners used a mix of sources: cash (53 percent), bank loans (43 percent) and money from friends or relatives (10 percent). Of those who borrowed from a bank, 66 percent used a home equity line of credit and 41 percent refinanced their home with cash out. Only 1 percent used a construction loan. Overall, 62 percent relied wholly or partly on savings or family money.

That tells you two things. Home equity is the main path. And the people who built ADUs were, on average, wealthier than the typical homeowner, which the researchers say reflects a lack of financing options for everyone else.

Option 1: Home equity line of credit (HELOC)

A HELOC lets you borrow against the equity you already have, usually at a variable rate, and draw money as the project needs it. It fits ADU projects because you pay builders in stages. The limit is your current equity. If you have not owned the home long, it may not cover the whole project. Some lenders offer renovation HELOCs that lend against the expected value after the project. Ask how the lender sets that value and when it is checked.

Option 2: Cash-out refinance

You replace your mortgage with a larger one and take the difference in cash. It can give you a fixed rate on the whole amount. The trade-off is that you reset your entire mortgage, which only makes sense if the new rate is close to what you have now.

Option 3: Renovation mortgages

Fannie Mae says ADUs can be financed with any Selling Guide loan product, including purchase and refinance loans, and that an ADU is treated like any other home improvement. Its HomeStyle Renovation product lists accessory dwelling units, in-law suites and basement apartments among the eligible improvements. FHA expanded its rules in 2023 and now allows ADUs to be financed under its 203(k) rehabilitation program and its new construction mortgages.

Fannie Mae's limits are worth knowing before you apply. ADUs are not eligible on a two- to four-unit property, a property with more than one ADU is ineligible, and its rules differ when the main home is a manufactured home.

Can the future rent help you qualify?

Sometimes, and less than you might hope.

• Fannie Mae lets lenders count rent from one existing ADU on a one-unit home, for purchases and limited cash-out refinances only. The lender uses 75 percent of the gross rent, and ADU income can be no more than 30 percent of your total qualifying income.
• FHA allows 75 percent of estimated rent from an existing ADU for some borrowers. For a planned ADU in a garage or basement conversion under 203(k), it can use 50 percent of estimated rent.

The key word is existing. For a new detached ADU, most lenders will qualify you on your current income.

Grants and public programs

California's CalHFA ADU Grant Program reimbursed up to $40,000 of predevelopment costs such as plans, permits, soil tests and fees. The state's ADU handbook says the funds have been exhausted. Some cities run their own fee waivers or loan programs. Ask your planning department directly, because these programs open and close.

How builders get paid

Site builders usually bill in stages as work is done. Prefab companies often ask for a deposit to reserve a factory slot, then payments as the unit is built. Before you sign:

• Tie each payment to a milestone you can verify, not a date.
• Ask what happens to the deposit if the permit is denied or delayed.
• Make sure your lender's draw schedule lines up with the builder's payment schedule.

Before you call a builder: answer six questions to pick a type, rough out a budget, and save builders to My Stack as you go.