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The demand for accessory dwelling units (ADUs) – and the capital necessary to fund their construction – is on the rise. How can you get in on the action, even if you don’t have all the cash on hand to fund the project in its entirety? If you’re looking for ways to finance an ADU, these eight ways may be right for your financial situation and long-term plans.
Yes! As housing demand grows in the hottest regions in the U.S., ADUs are widely seen as a cost-effective way to add affordable housing stock to in-demand markets. In recent years, local and state governments have made significant strides to remove legislative hurdles that could block ADU construction, such as parking requirements.
Research conducted by Freddie Mac found that the number of first-time ADU listings on the market grew 8.6% year over year between 2009 and 2019. First-time MLS real estate listings that include ADUs are up significantly, too: As of 2019, 6.8% of all active real estate listings included an ADU on the property. These figures are only expected to rise.
Aside from the general housing and political trends favoring ADUs, there are three strong reasons why ADUs are a good investment for the average homeowner. These include:
An ADU can increase your property value in several key ways, including:
Identifying and securing the right financing is one of the most crucial steps you’ll take as you plan to build your ADU. Thankfully, though, there are several options, each of which brings its own unique advantages and drawbacks to the table. These eight options can help you evaluate your financing options on a high level.
Sometimes called a second mortgage, a home equity loan allows you to borrow against the equity of your current home. The loan amount is given to you in one lump sum. You can then pay back this loan over time as set by your lender. This option is frequently utilized to make home improvements, ADUs among them. Keep in mind that this option may have sizable closing costs associated with it.
Also called a HELOC, a home equity line of credit also utilizes your home’s value to offer you a loan. However, unlike a home equity loan, a HELOC allows you to draw from the authorized amount as needed. For example, if you’re approved for $300,000, you can draw and repay $200,000 of that loan. Minimum payments are typically interest only, and interest is calculated from the day you withdraw funds from your HELOC.
Cash-out refinancing provides access to cash by refinancing your current mortgage. With cash-out refinancing, your lender will evaluate your home’s value against the principal balance left on your current mortgage. If it’s determined that your home’s value has increased, you may be able to refinance and receive the money in one lump sum.
Cash-out refinancing is typically done in conjunction with another major event, such as refinancing to secure a lower rate or switching lenders, so this may be a good option if you plan to refinance anyway for another reason. However, if you have little equity in your home or your home is not worth much, a cash-out refinance is not the right option for you.
This type of revolving credit account allows you to draw funds as needed from a pre-authorized amount, similar to a HELOC. However, unlike a HELOC, these lines of credit are unsecured – meaning, there’s no collateral for the lender to recoup in the event that you cannot pay the loan. As a result, personal lines of credit may incur higher fees or interest rates than a HELOC.
Construction loans provide short-term funding for the express purpose of building a real estate project. However, construction loans can come with higher interest rates, because construction is generally seen as riskier than taking out a mortgage on an already-built property – collateral that already exists. They can also have quite short repayment periods.
These factors make construction loans best if you know long-term funding for your ADU is coming in a matter of weeks or a few months from your construction start date. However, your lender may calculate your property’s worth based on after an ADU is constructed for purposes of the loan, which may get you access to more cash. Speak with your lender to get specifics on their process before making a commitment.
Local and state governments across the U.S. offer incentive programs to help add ADUs to the affordable housing stock in their communities. For example, California offers an ADU grant program that reimburses homeowners up to $40,000 for pre-development and non-recurring closing costs related to constructing an ADU. To find an eligible grant program in your community, speak with your local or state government’s housing authority, or conduct an internet search for ADU grants and programs in your community.
Private lenders do not hold to the same strict terms of a traditional financing institution, which means that it may be easier to secure financing from this type of lender. They’re known for fast decisions and closing timelines that can be much faster than a bank. However, private lending often comes with high fees or aggressive repayment periods, so this may not be the best option if you’re not expecting funds to repay your private loan quickly.
If you have to cash on hand, you can always pay for an ADU outright. There’s no requirement to secure lending to build your ADU. If you have the funds on hand to do so without borrowing, you can go straight to your ADU builder of choice and start the process. This option is best for someone who has the funds on hand and who wants to invest in either real estate or home improvement with their money.
Some potential homebuyers might get a little sticker shock when they consider the price of a new ADU. While the national average of ADU construction costs is around $150,000, that price greatly depends on the housing market. It also fluctuates based on region, building codes, energy efficiency and other green requirements, construction quality, and availability of labor.
For example, in a high cost of living area like the Bay Area of California, you may find that ADU construction costs clock in as much as $250,000 to $400,000.
However, the need to save money shouldn’t compromise quality. Cutting corners will cost you in the long run. Cheaper builds with low-end features can be frustrating for your tenants (or your guests, or yourself!), and low quality items tend to break down faster. That just means repair costs add up over time. Additionally, with labor in high demand, quick builds come at a premium price tag. Remember: You or your tenants will enjoy this space for many years to come, so the foundation you lay from the onset is crucial.
That all being said, there are ways to cut costs while still purchasing a quality build. By buying through a reputable company who has standard designs and finishes for your ADU, you can potentially save thousands based on their quantity of throughput. Some other ways to reduce or alleviate your ADU cost include:
How you choose to finance your ADU is a big decision that involves taking your personal and professional finances into account. But no matter which funding option you choose, Spacial is here to make the whole process easier.
With the help of a dedicated consultant, we handle all aspects of ADU construction for you, from permitting to total project management. All construction is conducted off-site, minimizing disruptions to your daily life. We prepare the foundation, power source, water lines, and sewer lines, then crane your ADU into place. The rest is history—welcome home.
