Whether you’re looking to build a guest house, add a rental unit, or create a space for family members, financing an Accessory Dwelling Unit (ADU) can be a key step toward increasing your home’s value and livable space. Deciding how to finance your ADU project can seem daunting, but it doesn’t have to be! Very few people want to refinance their primary mortgage currently, which eliminates products like the Cash Out Refinance and Homestyle Renovation Loan. Other than cash, that leaves three viable options to finance your ADU project that do not impact your primary mortgage - a Home Equity Line of Credit, Home Equity Loan, and Renovation Equity Loan.
We spoke with our preferred lender, Laura Witte of Truth and Lending, to get her insight on these products and ADU financing in general. “One of the biggest trends of 2024 that I believe is here to stay is the rise of ADUs and multi-generational housing. Over the past two years, we've seen a significant increase in purchases and financing for these types of homes, and we expect that trend to continue in the coming years. As baby boomers age and affordability issues persist, this is emerging as a permanent solution to these challenges. More extended families are living together, college students are returning home, and the demand for home offices or flex space is becoming a necessity. Some of the ways our existing homeowners are addressing these issues in a higher rate environment is with an equity line (HELOC) or a fixed rate second mortgage (Home Equity Loan). Each has their pros and cons and the good news is that both can be obtained without affecting your current low-rate first mortgage.”
A Home Equity Line of Credit (HELOC) is currently the most popular option to finance an ADU. If you have owned your home for several years you’ve likely built up equity, which is the difference between the amount you owe on your mortgage and what the home is worth. Typically, a HELOC allows you to borrow up to 80% of the equity in your home. One of the benefits of a HELOC is you can withdraw money as you need it and only pay interest on the amount you borrow. So it allows you to borrow exactly what you need, and typically the rates are lower than other forms of credit. The downside is that HELOCs have adjustable rates so your monthly payments will increase if interest rates rise. A good candidate for a HELOC is someone who has equity in their home and prefers the flexibility of ongoing access to money when they need it.
Just like a HELOC, a Home Equity Loan is based on the equity in your home and you can typically borrow up to 80% of that amount. The difference, however, is that a home equity loan has a fixed interest rate and a fixed payment schedule for the entire loan term, making them relatively easy to budget for. A Home Equity Loan also comes in a single lump sum, compared to a HELOC where you draw money as you need it. The downside is there is less flexibility than a HELOC and you cannot draw more money or redraw after paying it down. A good candidate for a Home Equity Loan is someone who has equity in their home and prefers the predictability of a fixed rate and payment.
A Renovation Equity Loan is a relatively new product that is a HELOC on the after-repair value (ARV) of your property including the primary home and the proposed ADU. You can borrow up to 95% of that value (with a max loan amount of $750k) so the borrowing power is much higher, and most importantly, it does not impact your primary mortgage unlike other ARV products. Another benefit is there is no draw inspection like a construction loan, so once you qualify, it is a simpler process. Lastly, the rate can be fixed or adjustable. The downside of a Renovation Equity Loan is unlike a HELOC, it cannot be redrawn, and comps of homes sold with ADUs are required to qualify, which can be hard to find. A good candidate for a Renovation Equity Loan is someone who doesn’t have enough equity in their home for a HELOC, or Home Equity Loan, and lives in a dense urban center with ADU comps. If this is you, reach out to our Renovation Equity Loan expert Bogdan Toderut at Summit Funding.
Now let’s crunch some numbers. We’re not loan officers so this is very rough math. Let’s say you bought your 2/2 bungalow in the City of Atlanta in 2016 for $300,000 with a 30 year mortgage and a 3.27% interest rate (lucky you). Now your home is worth $500,000 and your loan balance is $240,000 after 8 years of paying down principal and interest (amortization). That means you have roughly $260,000 in equity in your home. Then let's say you would like to build our 2/2 ‘KWood’ ADU that is currently in the range of $250,000 - $270,000 all in. If you finance the project with a HELOC you could access up to 80% of your total equity, or $210,000. In that case, you would need cash to finance the rest, or, for budget purposes, you could build our 1/1 'RTown' ADU, which is currently in the range of $200,000 - $220,000 all in. If your heart is set on the ‘KWood’ and you don’t have cash, and a HELOC won’t cover the full amount, your next option is a Renovation Equity Loan. Assuming an ARV of $850,000 (this number we did get from a professional) and a loan to value of 70-80%, you could easily borrow the full amount.
Lastly, let’s look at monthly payments. A $210,000 HELOC at an 8.5% interest rate would be around $1400 per month for the first 10 years (draw period) and around $1750 for the remaining 20 years (repayment period). If you borrow the full amount with a Renovation Equity Loan at 8.5%, it would be around $1900 per month for the first 10 years and around $2300 for the remaining 20 years. If you plan to rent your KWood, we have clients in East Atlanta who rent their KWood for $3000 per month long term, so not only would it cover the cost, it would create a nice supplemental income, even with 100% financing. And that is for a long term leased tenant - if you go the Airbnb route, like our clients in Reynoldstown and Ormewood, you can generate even more monthly income.
Financing any type of real estate in this current market is complex. There are several macroeconomic factors that impact housing, financing, and construction. ADU development fights some of these economic headwinds, but it also has significant advantages. The primary advantage is that you already own the land, and your backyard is a very valuable asset! This is your secret weapon that cannot be overstated. Zoning is also in your favor as ADUs are legal in 60% of residential zoning in the City of Atlanta. And if you have lived in your house for 5+ years, you've likely built a significant amount of equity that you can tap into without impacting your low-rate primary mortgage. So, while we would love to see Fee Simple ADUs become a reality in Atlanta, and ADU appraisal methods catch up with the market, these financing products are still really good options right now. And you have ATL ADU! Our turnkey service manages everything from the first email to the certificate of occupancy, so you don’t have to. Let’s make your ADU dream a reality and create more housing in our great city!