How to Finance an ADU in Los Angeles

It’s the home upgrade that everyone is buzzing about -- ADUs, or Accessory Dwelling Units. Whether you call them ADUs, granny flats or tiny homes, homeowners across Los Angeles are increasingly taking advantage of new rule SB CDMX CNN Gc con CBC corn de Chen c do nvm Cc c s and regulations that make it easier than ever to convert your attached or detached garage into a living space. Not only is a great way to increase your home’s value, but you can also generate extra income by renting out the space. Maybe you’re not looking to rent it out, but you want to have the extra living space for parents, in-laws, a son or daughter needing a place of their own.

So now that you’re thinking of building an ADU at your home, it’s time to tackle the most crucial step -- financing the project. You want to make sure it’s affordable upfront and a source of income for many years to come. No matter why you’re building the ADU, making the financing work is absolutely essential.

How much does an ADU cost in Los Angeles?

The first thing you’re going to have to do as a homeowner interested in building an ADU is pull permits with the city. City permits for such construction run about $2500, based on the construction costs. After that, you’ll work with an architect to draw blueprints for your construction, which will cost about $4,000-$7,000. After working with a general contractor, the total cost of your ADU will run between $100,000 to $150,000, depending on the square footage and other factors.

How do I obtain a Remodeling Loan for my ADU in Los Angeles?

The price of an ADU may be surprising at first. In fact, when ADUs were first legally allowed in California, the cost alone was prohibitive to all but wealthy homeowners. Fast forward a few years and ADUs are financially feasible for most homeowners. No need to worry. There are ways to pay for your new ADU without breaking the bank.

Home Equity Line of Credit – Used to fund my ADU

As a homeowner, you are probably already paying off your mortgage or you own your property. Either way, you can borrow against the value of your home.

One of the most common ways to borrow against the value of your home is through a home equity line of credit, also known as a HELOC. This is a line of credit secured by your home that gives you a revolving credit line to pay for large expenses.

To qualify for an HELOC, you need to have equity in your home. That means, the amount you owe on your home must be less than the amount your home is worth. You can usually borrow up to 85% of the value of your home, minus the amount that you owe. As you repay your HELOC, the amount of available credit is replenished, meaning you can borrow that money again, as needed. You can typically draw money from your HELOC for about 10 years.

Cash-Out Refinancing – Used to fund my ADU

Another way to pay for your ADU is through what’s called a cash-out refinancing of your mortgage. With a cash-out refinancing of your mortgage, you will get a lump sum payment. How?

Basically, you replace your current home mortgage with a new one. This new home mortgage would be higher than your current home mortgage. Then, you can take out the extra money and use it towards your ADU.

This is a great option when interest rates are low, especially if interest rates are lower than they were when you purchased your home. Also, the money you collect from a cash-out refinance isn’t considered income, so you don’t have to pay taxes on it. Instead of being considered income, the cash out is considered to be a loan.

Construction Loan – Used to fund my ADU

Yet another option is a construction loan. One of the many benefits of building an ADU is that it increases the value of your property. That makes it appealing to banks, who may give you a construction loan. With a construction loan, you would refinance with a mortgage that reflects the house's estimated value after you construct your ADU. Many lenders provide mortgages that cover up to 80% or 85% of the remodeled home's value.

With a construction loan, your bank will first assess the value of your property. Then, an appraiser will calculate how much they believe your home will be worth after an ADU is built. The bank will also take into consideration how much it will cost to convert your garage. Once all those factors are determined, the bank will provide a certain percentage of that difference for you to finance the cost of construction.

With a construction loan, the bank plays a larger role. The bank approves the general contractor selected by the homeowner. Then, the bank releases money at various stages in the construction process, which may involve an inspector verifying the progress. While these inspections may involve fees, this approach protects both the bank and the homeowner, who may not be familiar with how to oversee a major home construction project.

What are banks looking for in giving out loans?

When seeking out a conventional bank loan or a home equity line of credit, there are certain things banks are looking for.

● Credit history: A credit score is usually considered to be good at 680, but the higher the better. Some loan programs allow borrowers to have a score from 660 to 620.

● Debt to income ratio: This is the total amount of monthly debt payments you have divided by your monthly income. Banks are looking for a debt to income ratio of about 43-45%.

● Maximum loan to value: In general, a bank giving you a loan would like you, the homeowner, to have 20% equity in the property.

● Appraisals: These are required to borrow against the equity of your home to pay for the constructions costs of an ADU. The appraisals are based on the property’s current value. For construction loans, the appraise will also assess the future value of the property after the ADU is constructed based on the architectural plans.

● Rental Income: This is not considered part of the borrower’s income when you are building a new ADU. However, if a borrower can prove that they have a history of rental income from the property, then this income can count towards the owner’s income.

ADUs in Los Angeles

However you decide to fund your ADU, your new ADU can provide not only living space in this increasingly tight rental market, but also value for your home. In fact, ADUs can increase your property value by 20-30%!

There are many considerations to take into account when deciding to build an ADU on your property. In the end, the extra income it can generate and the added value to your home make an ADU a great choice. Give us a call if you have any questions. We can help you thought out the entire process.