In Treasure Valley, there have been numerous updates to city codes in recent years that have led to new opportunities for homeowners to build an ADU. With these easing restrictions, interest in building an ADU and financing an ADU has grown dramatically.
There are many benefits to building an ADU, and to help homeowners take advantage of these benefits, we’ve outlined different methods available for financing an ADU. Whether you’re building an ADU in Boise or elsewhere in Treasure Valley, you can use this information to better understand your financing options to make your ADU a reality.
Types of Financing For An ADU
Unlike financing for a custom home build, where some form of construction loan is typically necessary, when financing an ADU, there is a wider variety of financing options available. A construction loan is still an option when building an ADU; however, you also have financing options that utilize your current home equity, along with renovation loans and the possibility of working with a private lender using a hard money loan.
Because the cost of building an ADU is lower than building a larger custom home on your land, you may also have access to personal loans as a means of financing an ADU build. Other non-traditional financing options like grants or specific government programs may exist for those looking to build an ADU in certain areas, as well as the ability to use other non-standard like an investor cash flow loan (if you plan to use your ADU as a rental).
Equity-Based ADU Financing
For many homeowners who have built up equity in their current home or property, there are ways of financing an ADU that access the equity you already have in your home. Using an equity-based financing option can be beneficial; however, if your current equity doesn’t allow you to borrow the amount you need to cover your ADU build, you may need to look at different financing options or combine equity-based financing with a secondary funding source. Let’s take a look at a few different equity-based financing options.
Traditional Home Equity Line of Credit (HELOC)
A traditional home equity line of credit, also known as a HELOC, is a revolving line of credit that allows you to draw as needed and only pay interest on the amount you’ve drawn. This can be a particularly appealing type of financing for an ADU because you can draw on your line of credit in line with your ADU builder’s payment schedule and avoid paying some amount of interest that you’d pay if you borrowed a lump sum via another loan option.
Typically, the amount of a home equity line of credit is around 80-85% of the equity you have in your property minus any amount owed on your current mortgage. As an example, if your home value is $450,000, you still have $250,000 remaining on your first mortgage, your HELOC value is likely around $160,000 to $170,000, which is 80-85% of the equity you have in your home.
If you have enough equity to use a HELOC to finance your ADU, this is a great option to consider. However, if you don’t yet have enough equity in your home to cover the cost of an ADU with this type of loan, you may want to explore other options.
Home Equity Loan
A home equity loan is similar to a HELOC in that you are borrowing against the equity you have in your current home. The difference is that with a home equity loan, you’ll borrow a fixed amount of cash, versus having a line of credit you can borrow against as needed.
When you use a home equity loan, you’re essentially taking a second mortgage and agreeing to pay back the loan on a set schedule. Interest on this type of ADU loan is usually higher than a first mortgage, and you’ll need to pay closing costs and additional closing fees like lender fees.
Cash-Out Refinance
A cash-out refinance involves refinancing your first mortgage and relinquishing some of the equity you have in your home to finance your ADU build. The benefit is that you’ll have a single loan versus the multiple loans that you’d have with a home equity loan.
The interest rate for a cash-out refinance will align with current mortgage rates, so for some homeowners who have a current mortgage at a lower rate, this option would significantly raise interest rates and may not be worthwhile.
Again, with a cash-out refinance, as with the other equity-based ADU loan options, you’ll need to have built up enough equity for these options to cover the cost of your ADU. If you don’t yet have enough equity, another ADU financing option may make more sense.
Construction Loans For Financing An ADU
Construction loans can be a great option for financing an ADU, no matter where you are building in Treasure Valley. Construction loans for an ADU work in much the same way as a construction loan for a custom home build.
These loans are based on the future value of your property once your ADU is complete. Like any other construction loan, you’ll have a different payment schedule based on your build progress. Typically, a construction loan will have higher interest rates than a traditional mortgage, and you’ll have to pay closing costs & fees for a new construction loan.
On the other hand, if you don’t have much equity in your current home, a construction loan may enable you to borrow a greater amount of money to finance your full ADU build. If you need more funds than a home equity loan would allow, a construction loan can be a great option to consider.
Renovation Loans To Finance An ADU
A renovation loan can be another great option for financing an ADU build in Treasure Valley. This type of loan product uses your property’s expected post-renovation value, that is, the value of your property once your ADU has been added, to determine the loan value.
Renovation loans typically have lower interest rates than other financing options like personal loans, credit cards, and potentially loans from private lenders. They also tend to have longer repayment periods, such as 15, 20, or even 30 years, similar to those of traditional mortgage products or construction-to-permanent loans. Another great benefit of using a renovation loan to finance an ADU build is that certain renovation loans come with tax-deductible interest.
Below are a few examples of renovation loans available; however, you can talk with your local lender here in Treasure Valley to find out about their current renovation loan options for the most accurate information and options you qualify for.
203k Loan (FHA 203k)
In 2023, the U.S. Department of Housing and Urban Development announced a new policy that allowed ADUs as a qualified type of home improvement for FHA mortgages for new constructio,n along with other ADU-related changes to FHA mortgage products.
The 203k Loan, also known as the FHA 203k, is one type of loan product that can now be used for financing an ADU. This type of loan combines the cost of a home plus renovation expenses into a single loan. It can be used for the initial home purchase as well as during a refinance.
This can be a great option if you are purchasing a new property and want to add an ADU at the same time. Similar to other types of FHA loans, one benefit of the 203k loan to finance an ADU is the lower down payment requirement (3.5%).
In some cases, a 203k Loan can include 50% of the expected rental income from the ADU to qualify for this loan, which can be particularly appealing for homeowners planning to use their ADU as a rental property.
Fannie Mae HomeStyle Renovation Loan
The Fannie Mae HomeStyle Renovation Loan is similar to the 203k Loan, but backed by Fannie Mae instead of the FHA. This loan type also combines the home cost + renovation (aka your ADU build) into a single loan. It can be used to refinance or for those who are buying a new property in Treasure Valley, Idaho, and want to build an ADU.
There are a few differences from the 203k Loan. One is a slightly higher down payment requirement. This loan also comes with greater flexibility in the type of improvements allowed versus the 203k Loan. It’s worth looking into if you’re hoping to roll your primary dwelling and ADU financing into one loan product. See the Fannie Mae website for more information on Fannie Mae ADU Loan options and requirements.
Non-Standard ADU Financing Options
ADU Grants
In some areas, like California, there are grants available to help homeowners finance an ADU. These often come with stipulations on how your ADU can be utilized; however, they are worth considering as a grant, unlike an ADU loan, which does not need to be repaid and can be a great way to support the financing of an ADU.
In Treasure Valley, there are currently no government-sponsored ADU grants available; however, in 2021, Boise ran a pilot program that offered financial incentives to homeowners who wanted to build an ADU. This program was designed to incentivize homeowners to build ADUs as affordable housing options and required ADU owners in the program to rent their ADUs at affordable rates for a period of 10 years following completion. While there was a lot of interest in the program, it was not adopted in high numbers, and the program is currently being revised based on the learnings of the pilot.
Although not widely available in Treasure Valley at present, we mention ADU grants as an option because, should a new ADU incentive program be launched in the future, it would be beneficial to take a look at any funding programs available to determine if they are viable financing methods.
Debt Service Coverage Ratio (DSCR) Loan, aka Investor Cash Flow Loan
A debt service coverage ratio loan (DSCR), also known as an investor cash flow loan, is a type of non-qualified mortgage loan. This means it has different loan criteria than traditional loan criteria set by the Consumer Financial Protection Bureau, and the loan is not backed by Fannie Mae, Freddie Mac, or another government institution.
A DSCR loan focuses on a rental property’s cash flow to determine the loan amount, instead of looking at personal income as a qualification for the loan. Because this loan type is designed specifically for real estate investors looking to rent their properties, this is an ADU financing option for homeowners who would like to use their ADU as a rental.
To calculate the DSCR of a rental property, divide expected monthly rental income by the sum of principal, interest, property taxes, homeowners insurance & any association (HOA) dues, also known as PITIA.
Usually, a DSCR loan would require a DSCR of 1.0 or higher. This means your expected monthly rental income should equal or exceed your PITIA if you’d like to use this type of loan.
A few reasons to use this type of loan for financing your ADU include that it has more flexible income and credit requirements than other loan types. However, a DSCR loan also comes with higher interest rates and often a larger down payment requirement.
Nonbank Lender / Private Lender ADU Loan
If a more traditional loan for the financing of your ADU is unavailable, there are alternative options through private lenders. You can look specifically for hard money lenders, lenders that will focus more on the value of the property you are using to secure your loan, rather than focusing more specifically on your creditworthiness.
The upside of finding a private lender is the ability to secure an ADU loan when you may not otherwise have been able to. Loans from private lenders also typically have a faster turnaround time, meaning less delay for you to get started on your ADU build.
It’s also important to note that an ADU loan from a private lender may come with higher interest rates and shorter repayment terms compared to more conventional loans, like the HELOC or construction loans.
If you are looking to build an ADU in Treasure Valley, there are a number of private lenders focused on hard money loans for real estate investors. If you’d like help getting connected with a private lender in our area to talk about an ADU loan, we have relationships with many area lenders and may be able to connect you with a lender that can help. Reach out to us and let us know what you’re looking for.
Personal Funding Options
In addition to all of the other loan options you have available for financing an ADU, you also have personal funding options available. The benefit of financing an ADU versus a full custom home build is that the cost for a smaller unit is naturally smaller. This is where personal funding, like a personal loan or a credit card, can be beneficial if not for the full cost of your ADU build, for a portion of it.
Personal Loans
Personal loans are tied to your personal credit worthiness, which for some means a higher limit, while for others, this may only cover a portion of your ADU build. Typically, personal loans will have higher interest rates than more traditional financing, such as equity financing options. If you need to fill a gap in how much you can borrow with another ADU loan type or if you don’t have much equity to borrow against, a personal loan is another option to explore.
Credit Cards
Financing an ADU with credit cards will have the highest interest rates compared with almost every other funding source. However, like personal loans, you may use credit cards to fill in any gaps you have from other ADU loans.
Cash
If you have it, financing your ADU with cash is the easiest and likely lowest-cost option. You won’t need to pay any loan fees or interest, so the cost of your ADU build is the final cost when you use cash.
Of course, like any investment, you can weigh the pros and cons of using your cash for an ADU versus another type of investment to determine if this is a good option for you.
Any Combination of Financing Options
As we’ve noted in the personal funding section, you can also use a combination of any of these options to finance your ADU. If, for example, you don’t have enough equity to use a home equity loan to cover the full cost of your ADU, you might consider pairing that with another loan type or other personal financing source to get to the full amount needed to build your ADU.
Unlike a custom home build or a home purchase where traditional funding methods dominate your options, when you are building an ADU, you have many different financing options available. Some options work best if you already have equity built up in your current property, others are better suited to refinancing or buying a new piece of property and adding an ADU right away, and there are others that work best if you plan to rent your ADU.
No matter what your situation is, there is likely an ADU financing option available to you. If you are considering building an ADU in Treasure Valley, use our previous projects and ADU home plans for inspiration for your ADU. You can also check out our other ADU resources or get in touch with us to discuss building your ADU. We’d love to help you turn your ADU plans into a reality.
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