By Bill Lyons | Updated on February 11, 2025

Accessory Dwelling Units (ADUs) have seen significant growth in the United States over the past decade. A study by Freddie Mac identified approximately 1.4 million properties with ADUs nationwide, highlighting a notable increase in their prevalence.

Between 2009 and 2019, the number of first-time ADU listings grew at an average annual rate of 8.6%, indicating a rising interest among homeowners and builders.

This upward trend is particularly evident in certain regions. For instance, in California, ADU construction spiked from 1,100 units in 2016 to 23,600 units in 2021, demonstrating the state’s efforts to address housing shortages through ADU development.

Moreover, a 2021 study estimated that there are about 1.5 million ADUs in the U.S., accounting for roughly 2% of all homes in the country. The same study noted that ADUs were growing at a rate of 9%, or 100,000 units per year, underscoring their increasing role in the housing market.

TABLE OF CONTENTS

    With the right ADU loan, you can build the kind of ADU you want and start earning passive income. In this article, we’ll explore various methods and loans for financing ADUs to help you capitalize on this growing trend.

    KEY TAKEAWAYS

    • ADUs offer a flexible housing solution, serving various purposes, such as accommodating family members, generating rental income, or creating a home office.
    • Building an ADU can provide additional income through rental opportunities and enhance property value while offering flexibility for homeowners’ changing needs.
    • There are many ADU financing options to choose from, including cash-out refinancing, home equity loans, home equity lines of credit, DSCR loans, and construction loans.

    What Is an ADU?

    An ADU is a secondary living space located on the same property as the primary residence. Also known as an in-law suite, ADUs are separate living quarters equipped with the same essential amenities as the main house, including a kitchen, bathroom, and sleeping area. These units can be attached to the main home, such as converting a garage or basement, or they can be detached structures like standalone living spaces in the backyard. 

    ADUs offer a flexible housing solution, serving various purposes for homeowners. They can provide additional living space for family members, offer rental income opportunities, or serve as a studio or home office. The versatility and relatively compact size of ADUs make them a popular choice for maximizing the utility of the property without the need for extensive construction or property expansion. 

    In general, Fannie Mae ADUs and ADU financing from lenders are treated similarly to other types of home loans. 

    Why Build an ADU?

    Building an ADU can offer homeowners a range of benefits, including: 

    • Additional income: One of the primary advantages of constructing an ADU is the potential for generating rental income through short-term rentals. Homeowners can rent out the ADU to tenants, providing a steady revenue stream and helping to offset mortgage or maintenance costs.
    • Multigenerational living: ADUs offer a solution for accommodating multigenerational households. Whether housing aging parents, adult children, or other family members, the separate living space provides privacy and independence while keeping the family close. 
    • Property value: Adding an ADU can enhance the property’s overall value. The extra living space and potential for rental income make the property more attractive to potential buyers, potentially increasing its market value. 
    • Flexibility: ADUs can serve various purposes, adapting to homeowners’ changing needs or desires. From a home office or workshop to a guest suite or personal space, the flexibility of ADUs allows for versatile use based on the homeowner’s changing lifestyle. 
    • Quick construction: ADUs often have quicker construction timelines compared to major home expansions. This efficiency is particularly advantageous for homeowners looking to add living space without undergoing extensive and time-consuming construction projects. 
    • Affordability: ADUs are relatively affordable to build compared to traditional home expansions. They often utilize existing space, such as garages, reducing the need for additional land. This affordability makes ADUs an accessible option for homeowners looking to increase living space without a substantial financial burden. 

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    How Much Does Building an ADU Cost?

    The cost of building an ADU can vary based on several factors, including the project’s size, scope, and location. Different cities may have varying permit fees and construction costs, so it’s crucial to consider these aspects.

    The most substantial expense in building an ADU is typically the construction costs. This includes materials, labor, and contractor fees. The size and complexity of the ADU, as well as the quality of materials used, will significantly impact these costs. 

    Your contractor can also help obtain the necessary permits for building an ADU, which comes with fees. These fees can vary depending on the city and type of permits required.

    Connecting the ADU to utilities like water, sewer, and electricity also comes with costs. Depending on the existing infrastructure on the property, these connections may require additional work and expenses. 

    Consider setting aside a contingency fund for unexpected expenses that may arise during construction. Unforeseen issues or changes to the original plan can impact your budget, and having a contingency fund helps manage these situations. 

    5 ADU Financing Options

    Financing an ADU requires careful consideration of your available options to ensure a financially sound and feasible type of investment. Here are five loans for ADUs you might consider: 

    1. Cash-out refinance

    A cash-out refinance involves replacing the existing mortgage with a new one that has a higher principal amount. The homeowner receives the difference between the old and new mortgage in cash, providing the necessary funds for the ADU construction. 

    One significant advantage of this approach is the potential for lower interest rates typically associated with mortgage loans. Additionally, the interest paid on mortgages may be tax-deductible, offering potential financial benefits. 

    However, it’s essential to consider that opting for a cash-out refinance increases the overall debt on the property, and some lenders may have stringent requirements for qualification. 

    2. Home equity loan (HELOAN)

    Another financing avenue for building an ADU is a home equity loan. HELOANs allow homeowners to borrow a lump sum based on the tappable equity accumulated in their property. HELOANs operate as second mortgages, with fixed payments over a predetermined term. 

    The fixed interest rates provide stability for budgeting, and homeowners receive the entire loan amount upfront, simplifying financial planning for the ADU project. 

    However, it’s crucial to note that interest payments are applied to the entire loan amount, and approval for a HELOAN may depend on the homeowner’s creditworthiness and the equity available in the property. 

    3. Home equity line of credit (HELOC)

    A home equity line of credit is an alternative option for financing an ADU. Similar to a home equity loan, a HELOC allows homeowners to leverage the equity in their property. However, a HELOC functions more like a credit card with a revolving line of credit.

    Homeowners can borrow as needed, paying interest only on the amount used. This flexibility can be beneficial for managing construction costs, allowing homeowners to draw funds incrementally as the ADU project progresses. It may also help those who aren’t quite sure what their construction costs are and may need additional funds to complete the project.

    While HELOCs often come with variable interest rates, offering flexibility, borrowers should be mindful of potential fluctuations in interest payments. If you’re interested in a HELOC that offers more predictable payments, we offer a fixed-rate HELOC loan as well.

    4. DSCR loan

    For those considering renting out the ADU, a debt service coverage ratio (DSCR) loan might be a good option. DSCR is a financial metric that assesses a property’s ability to cover its debt obligations, including the mortgage loan. This type of mortgage loan doesn’t consider the borrower’s personal income. Instead, it solely focuses on the property’s ability to generate sufficient income to cover its debts.

    For ADU financing, a DSCR loan considers the potential rental income generated by the ADU. This type of loan is specifically designed for income-generating properties, making it ideal for ADUs intended for rental purposes. 

    It’s important to note that DSCR loans aren’t used for personal-use ADUs, which means these loans aren’t available for those who want to build an ADU for a home office or for their parents or children to live in. However, if your family members are paying rent, a DSCR loan might be a feasible option. 

    These ADU loans require a clear plan for renting out the additional unit to demonstrate the ability to cover loan payments. Your lender will need to see information regarding how much you plan to rent the ADU for and calculate ROI, so you’ll need to perform market research. DSCR loans offer a unique approach for those looking to offset ADU construction costs through rental income, but they require strategic planning. 

    Additionally, if you plan to rent out your ADU, you’ll essentially become a landlord with various responsibilities, such as tenant relations, property maintenance, and adherence to landlord-tenant laws. 

    5. Construction loan

    An ADU construction loan is a specialized financing option tailored for individuals undertaking construction projects, making it a suitable option for building an ADU. Construction loans for ADUs are designed to provide funds specifically for the construction phase of the project.

    A cutout of a home, a hammer, a leveling tool, a tape measure, pliers, and a keyboard sit on top of a set of blueprints.

    Initially a short-term loan, a construction loan allows homeowners to access the necessary capital to cover construction costs. One notable feature is that during the construction period, homeowners can make interest-only payments, reducing their financial burden. Once the construction is complete, the loan is typically converted into a permanent mortgage.

    The advantages of a construction loan include its tailored focus on construction needs, ensuring that the funds are used efficiently for building the ADU. However, interest rates for these ADU loans may be higher compared to traditional mortgages. Additionally, since these loans are only used for the construction of the ADU, you don’t have any available funds left over for the design or any other additions you want to make to the ADU to make it feel more like a home. 

    ADU Loan Rates: How Are They Determined?

    Whether you’re building a rental space or a guest house, understanding how ADU loan rates are determined can help you get the best deal. ADU loan rates aren’t one-size-fits-all—they depend on a mix of factors. Here’s a breakdown of what can impact your interest rate:

    • Your credit score: Credit scores play a big role when it comes to ADU loan rates. The better your score, the lower the rate you’re likely to get because lenders see you as less risky. If your score isn’t where you’d like it to be, taking time to improve it could lead to big savings in the long run.
    • Down payment amount: The size of your down payment matters. A bigger down payment can lower your interest rate because it lowers risk for the lender. If you can swing a larger upfront payment, it might be worth it to lock in a better rate.
    • Your income: Lenders want to know if you have the income to cover your monthly payments comfortably. A steady income stream signals you can handle the loan, which can help you snag a better rate.
    • Your overall financial picture: It’s not just about your income—lenders look at your full financial profile, including your savings and debt-to-income ratio. A strong financial foundation can make you a more attractive borrower and lead to better terms and rates.
    • The loan type you choose: Different loans come with different rates. Fixed-rate loans and adjustable-rate loans will carry different interest rates. Additionally, loans that are secured by your home equity — such as second mortgages and home equity lines of credit — typically come with more competitive rates. Compare mortgage options and see what you qualify for to find the right fit.
    • What’s happening in the economy: Sometimes, it’s all about timing. Interest rates are influenced by market conditions, like inflation and Federal Reserve decisions. The current economic environment will play a large role in determining the ADU loan rate you qualify for.

    Reach Out to Learn More About Loans for ADUs

    Financing the construction of an ADU involves careful consideration of the various mortgage options tailored to individual needs and circumstances. Consider why you’re building the ADU — is it for accommodating family or personal use, or are you planning to use it to generate rental income? Cash-out refinances, HELOANs, HELOCs, DSCR loans, and construction loans each offer unique advantages and considerations. When choosing the best ADU financing method, you should weigh factors like interest rates, repayment terms, and eligibility criteria. 

    Explore the best financing solutions for your ADU project with Griffin Funding. With our expertise in mortgage lending and commitment to client success, we can provide valuable insights, answer questions, and assist you in understanding your ADU loan options. Reach out to get started today or download the Griffin Gold app to learn more about our mortgage options and leverage smart financial tools that can benefit both current and aspiring homeowners.

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    Frequently Asked Questions

    Is building an ADU worth it?

    Building an ADU can be a great investment, but it’s not for everyone.

    ADUs can generate steady rental income, helping to offset construction costs while potentially increasing your property’s overall value. They also offer flexibility, and in areas with housing shortages, an ADU can make your property more appealing and marketable. 

    However, there are challenges to consider. Upfront costs can be high, and zoning laws, permits, and construction timelines can lead to unexpected delays. Lastly, not all properties are suitable for an ADU, so evaluate your space and understand local regulations before locking in any plans.

    Can I use the potential income of an ADU to qualify for a higher loan amount?

    Yes, this is possible. Some lenders allow borrowers to include the anticipated rental income from an ADU when determining their eligibility for a loan. However, this varies by lender and loan type, so it’s important to look into this first.

    If you do want to use potential rental income to qualify for an ADU loan, consider applying for a DSCR mortgage. A DSCR mortgage doesn’t look at a borrower’s personal income, but instead considers the property’s cash flow versus its debt obligations. 

    What’s the best way to finance an ADU right now?

    The best way to finance an ADU depends on your financial situation, goals, and preferences. When considering how to financing building an ADU, take into account the strengths and weaknesses of each loan option and determine whether they align with your goals: 

    • Home equity loans can be a great option if you have equity in your property, giving you a lump sum with a fixed interest rate. 
    • Cash-out refinancing allows you to refinance your mortgage while taking out extra cash for your ADU project, often at competitive rates, though it will extend your mortgage term. 
    • DSCR loans allow you to qualify for financing without using personal income. This can be a good option if you’re looking for an investor-oriented mortgage product to build your ADU with. 
    • Construction loans are tailored specifically for building projects, covering labor and material costs with flexible repayment options. 
    • Hard money loans provide quick access to funds but usually come with higher interest rates. 

    Not sure which ADU loan option is right for you? Reach out to Griffin Funding today and we can help you compare your mortgage options. 

    Bill Lyons

    Bill Lyons is the Founder, CEO & President of Griffin Funding. Founded in 2013, Griffin Funding is a national boutique mortgage lender focusing on delivering 5-star service to its clients. Mr. Lyons has 22 years of experience in the mortgage business. Lyons is seen as an industry leader and expert in real estate finance. Lyons has been featured in Forbes, Inc., Wall Street Journal, HousingWire, and more. As a member of the Mortgage Bankers Association, Lyons is able to keep up with important changes in the industry to deliver the most value to Griffin's clients. Under Lyons' leadership, Griffin Funding has made the Inc. 5000 fastest-growing companies list five times in its 10 years in business.