How to finance an ADU and increase your home value #CashNews.co

Adding another unit, often called an accessory dwelling unit or ADU, to your home or yard can be an attractive feature that boosts the value of your property.

You might want to build separate housing to accommodate a family member or to generate income by renting out the space. These ADUs come in all shapes and sizes and can increase the sale price of your home. But there are local zoning laws, rental requirements, and financing options you should be aware of before building ADU housing.

What is an ADU?

An ADU is a secondary type of housing unit on a single-family residential property. ADUs are often smaller units that might be a converted basement or garage, or an additional cottage-like house in the backyard of your primary home.

As the name implies, an ADU is an accessory unit to your main house or property that comes with its own kitchen, bathroom, and separate entrance. ADUs are often called in-law suites, where a homeowner might want to offer their college student or aging relative a private space nearby at a low cost or for free.

You can also rent out your ADU to generate additional income, whether it be a long-term rental or a short-term rental like an Airbnb.

An ADU typically boosts your property value or sale price, which could be lucrative if you intend to sell your home down the road. However, if you sell your home, you will probably need to sell the ADU as part of the property transaction.

Types of ADUs

There are many different kinds of ADUs, the most common being the following:

• Converted garage attached to your primary house

• Converted basement or attic inside your home

• Detached new construction dwelling, like a cottage home or granny flat in the yard

• Bump-out ADU, which is an additional space sharing a wall with your primary home

• ADU space built within your primary home

The features of an ADU will heavily depend on your local planning and zoning laws. ADUs must have a kitchen, toilet, and separate entrance, and most laws state that the homeowner must reside in either the main living space or in the ADU itself. But some municipalities will place other restrictions, like limiting the size of the unit.

What to know about ADUs and zoning laws

If you intend to build an ADU on your property, you will need building and zoning permits. Laws vary by state and municipality and might restrict how you can use the ADU, so it’s critical to check both your local zoning laws and any rental restrictions.

Some cities encourage ADU development, especially if it can provide more affordable housing in a major metro area with strong housing demand. However, some of these cities might place heavier restrictions on renting out your ADU.

For example, California encourages ADU developments to provide more housing for low-to-moderate-income families. The state offers an ADU grant program for up to $40,000 to help reimburse homeowners who build an ADU for this purpose.

In 2023, the city of Phoenix, Ariz., amended its zoning laws to permit one ADU per single-family detached home. However, the city restricts homeowners from using any ADUs as short-term rentals because it intends for ADUs to help with the housing shortage rather than to bring in tourist revenue.

You can also consult with an attorney to make sure you meet all of the local zoning and rental laws.

How much does it cost to build ADU housing?

The cost to build an ADU will vary greatly depending on whether it’s an attachment to your house, an upgrade to an area within your home, or an entirely new structure in your yard. You should also factor in the costs for any required building or zoning permits.

Your expenses can range from tens of thousands of dollars for a small upgrade to more than $100,000 if it’s an entirely new structure or major renovation.

How to finance an ADU

If you don’t have a lot of cash on hand, there are ways to finance building an ADU. Here are some options:

• ADU grant program: Some states, municipalities, and nonprofit organizations offer grants for building ADU housing. A grant is different from a loan in that you do not have to repay the money.

• Construction loan or renovation loan: These are loans for building new structures or making major updates to your existing home. You’ll apply for these loans with a mortgage lender, so ask your lender which would be the best fit for your project and financial situation.

• Mortgage refinance: If you’ve built up significant equity in your home, you could do a cash-out refinance and use the money to pay for the ADU.

• Home equity loan: This is another tool for tapping into your home equity, except it’s a type of second mortgage. So, instead of refinancing, you’ll have a home equity loan on top of your regular mortgage. You’ll receive a lump sum of money and pay it off over a predetermined period.

• Home equity line of credit (HELOC): A HELOC is another type of second mortgage, except you don’t receive your money in a lump sum. Instead, you have a draw period when you can take money as needed, and you only pay interest on the money you actually borrow. This could be a good option if you’re not sure how much money your ADU project will cost.

Be sure to weigh all your financing options ahead of time because each mortgage lender will have different requirements depending on the type of loan, your property, and your financial situation.

Yahoo note: Looking for a big-name mortgage lender with ADU loans? Read our Cardinal Financial mortgage review to see if it’s the right fit for your ADU.

Other types of housing

FAQs about ADU housing

Do I need a permit to build a guest house?

Yes, you will likely need a permit from your local jurisdiction to build a guest house or ADU. If it’s a habitable living space, you are typically required to obtain a building permit.

Is it legal to build an ADU or guest house in my backyard?

Every jurisdiction will have different rules on whether you can build an ADU or habitable space in your backyard. Some allow it, while others might restrict it, depending on the type of structure and how it’s classified.

For example, your local zoning law might not allow an ADU, but it could permit a guest house or a detached bedroom. That’s why it’s important to check your local zoning laws before building a structure in your yard.

Can an ADU house add value to your property?

Yes, additional spaces like a guest house or an ADU add value to your property. According to a 2021 study by home software company Porch, an ADU can add up to 35% more value to your property if it’s located in a large U.S. city.

If you plan to sell the property, having a permitted ADU will signal to potential buyers that they might be able to earn rental income from the property.