4 Different Categories of How People Pay for ADUs

In 2021, Respondents of a UC Berkeley survey of more than 800 homeowners were questioned about how they financed the cost of building ADU. Their responses were divided into four different categories:

  1. Liquid assets: Most homeowners use cash or other liquid assets for their ADU construction. Homeowners who lack sufficient liquid assets to cover the cost of building an ADU need other sources of funds.
  2. Mortgages: Mortgages are the most commonly used source of debt for ADU buildings because of relatively low-interest rates, wide availability, and high borrowing limits for homeowners to lend sufficient money to cover all the ADU construction costs. 
  3. Unsecured debts: Homeowners rarely use other kinds of debts, such as personal loans or credit card loans; these debts have high-interest rates and can make limited cash. 
  4. Other: Other non-debt sources are ground leased, government funds grant utilization, and equity share models.

Types of mortgages:

Respondents also talked about the type of loan they had taken. There are three main kinds of mortgages for ADU building:

  • Home equity loans/ home equity line of credit (HELOCs)
  • Cash-out refinances
  • Renovation loans

HELOCs (Home equity lines of credit):

HELOCs and home equity loans (together “second lien loans”) are loans secured by the real property but subordinated to the first mortgage of the homeowner. The primary difference between a home equity loan and a HELOC is that all the funds are paid to the borrower at the loan’s closing in home equity loan, while in a HELOC, a borrower can withdraw funds as needed. Second-lien loans grab the attention of homeowners with an interest rate on their first mortgage that is less than what they could get with a cash-out refinance.

Cash-out refinance:

It’s a first-lien mortgage used by homeowners to switch their current smaller mortgage. Cash-out refinances are accessible to individuals who already have equity in their homes (built up through principal payments or home appreciation over time). Cash-out refinances usually have higher rates of interest as compared to purchase loans, and non-cash-out refinances but are less than renovation loans and second lien loans. Borrowers require equity in their homes for taking out cash-out refinance or a second lien loan; it’s not a reality for many people. 

Renovation loan:

It is a first-lien loan intended to offer homeowners the cash they require to buy a new house or to fund an existing mortgage, in addition to cash to renovate a home like remodeling a kitchen, fixing a roof, or constructing an ADU, among other kinds of qualified improvements. Renovation loans are similar to other mortgage types with a few differences. After the renovation is done, the renovation loan works as any other first lien mortgage. VA, FHA, Freddie Mac, and Fannie Mae provide renovation products. Currently, renovation loans are a relatively small part of the ADU financing landscape. 

After identifying the ADU financing landscape, our team is trying to figure out how government-backed mortgages could assist and improve ADU construction. 


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