ADU Financing: 10 Things You Need to Know

Accessory Dwelling Units (ADU) are steadily increasing in popularity as many people across the country turn to these additional living spaces as the solution to an expensive housing market. Unfortunately, ADUs don’t pay for themselves, and you should approach financing them in a smart yet affordable manner. That’s why Zook Cabins is giving you the ultimate guide to ADU financing, from which loans are the smartest choice, to state grants and federal funding, and more essential nitty gritty details. If you are starting your ADU financing journey, we are here to support you every step of the way. Let’s dive right in! 

Disclaimer: The content of this blog is for informational purposes only and does not constitute financial advice. Always do your own research and consult with a qualified financial advisor or professional before making any financial decisions. 

1.) Can ADUs Be Financed? 

Yes! Many lenders today are open to financing ADUs because of their rising popularity and income potential. 

And just like a traditional home, there are multiple options for you to finance your ADU whether you choose to take out a Home Equity Line of Credit (HELOC), refinance your mortgage with a cash-out refinance, or do a construction loan.  The video above offers a quick overview of each option, but keep reading and we will dive deeper into the pros and cons of each of these financing options. Bottom line? Financing ADUs is very doable and you can start the process today! 

2.) Can I Do A HELOC To Finance My ADU?

One of the most popular ways to finance an ADU is utilizing your current home equity. Known as Home Equity Line of Credit (HELOC), this loan finances your ADU using the equity in your home. 

Think of it as a revolving credit line where you are approved for a maximum limit (typically up to 85% of your home value) and you can “withdraw” money as needed during your time limit (5-10 years). 

Compared to a traditional loan where you receive the whole set amount at the beginning, a HELOC is ideal for financing ADUs that have a changing budget or a scheduled construction timeline. However, if your home does not hold enough current equity, you may not qualify for a HELOC to finance your ADU.  

Many homeowners use HELOCs to cover smaller costs like permits and set up costs, then later draw more funds as construction progresses. Interest is usually lower than unsecured loans because your home secures the loan, and you only pay interest on the amount you actually borrow. Many lenders like Figure.com or Bank of America are willing to work with financing ADUs through a HELOC. 

Note: Your small local bank may offer HELOCs at a better rate than larger, national lenders. Always compare all your options before getting a HELOC.

Pros 

• Retain your primary mortgage 
• Flexible money withdrawal 
• Tax-deductible interest (depending on what the money is used for) 

Cons 

• Variable interest rates 
• Foreclosure risk 
• Credit line is dependent on the current market 

3.) Can I Do A Cash-Out Refinance To Finance My ADU?

Another popular option for financing your ADU is a cash-out refinance, where you replace your current home mortgage with a new one that uses your home equity as a form of cash income. 

The difference between your existing mortgage and the new loan is paid to you in cash, which you can use to finance your ADU. A cash-out refinance is great if you have substantial equity in your home and want to access more funds that can then pay for your ADU. 

Cash-out refinancing also tends to offer lower interest rates than HELOCs or personal loans because it’s spread across a long mortgage term. However, it may not be the best option if you already have a low-interest mortgage that you’d be replacing. A cash-out refinancing calculator may be helpful in the decision making process. 

Pros 

• Lower interest rates 
• Combined loan and rate 

Cons

• Loss of current mortgage 
• Closing costs are similar to getting a new mortgage 

4.) Can A Construction Loan Be Used To Finance My ADU?

A construction loan is the third option for financing your ADU and while not as popular, some homeowners still turn to it as a solution. Construction loans are short-term builder loans based on the value of your home, or in this case, your ADU, after renovation, and upon completion of construction, the homeowner converts the construction loan into a more permanent mortgage.

This is preferred if you are building your ADU but if you are purchasing a modular ADU, it may not be the loan for you. In fact, many lenders do not recommend a construction loan based on their high interest rates and short timelines. 

Pros 

• Tailored to construction timelines
• Based on the future value of your property

Cons

• Fluctuating interest rates 
• Higher interest rates 
• Requires refinancing at the end of construction 

Helpful Tip: Before choosing a specific type of financing, make sure you are comparing all of the options to see what you qualify for. Utilize tools like our short-term investment calculator or Lending Tree to get a better idea of what financing your ADU can mean. 

5.) Can My ADU Financing Request Be Denied?

Unfortunately, there are times when your ADU financing request may be denied. There are a variety of reasons, and they can typically be avoided with some good planning and a little financial savvy. Here’s a list of possible reasons your ADU finance request may be denied. 

1. Insufficient Equity: As mentioned earlier, HELOC loans require 15-20% equity for lenders to finance your ADU. If you lack that in home equity, lenders may refuse your financing request because they see it as risky for them. 
2. Low Credit Score: Credit and debit scores can influence the financing process when you find a lender. If you have a poor or very low credit score, lenders will be hesitant to assist in financing your ADU.
3. Lack of Correct Permits: When you go to a lender for a loan, you must have all the necessary paperwork ready, including approved permits or in-progress applications. Lenders do not finance illegal projects and without the correct permits, they may deny your financing request. 
4. Zoning Requirements: Some local municipalities may not allow you to have an ADU on your property due to zoning requirements, causing lenders to turn down your financing application. Before beginning the financing process, look over this table to see your state’s ADU regulations. 
5. Incomplete Construction Plans: Certain lenders may require you to have the complete construction blueprints before they approve your loan. When you purchase a modular ADU from Zook Cabins, you will receive the complete blueprint package complete with building contracts that you can present to your lending agency. 

6.) Are There Any Grants To Help With Financing My ADU?

If a loan doesn’t fully cover the cost of your ADU or you’d like to explore other financing options, there are several grant programs available from federal and state sources to local initiatives, all designed to support homeowners building or purchasing ADUs.

Federal Programs 

Right now in the US, there isn’t a set federal ADU grant program but there are several general home grant programs that may apply to your ADU. The US Department of Housing and Urban Development offers discretionary housing grants on Grants.gov where you can apply for federal financial assistance for your ADU. More and more, the federal government is viewing ADUs as a way to improve the housing market and create affordable living options, which may increase federal ADU grants in the future. 

State Programs 

Certain states, particularly those with larger urban areas, offer a variety of state grants that can boost a homeowner’s ability to purchase an ADU. These state grants can provide thousands of dollars of financial assistance to homeowners but proceed with caution, as grants can impact the usage of your ADU. We dive deeper into those implications and details on specific state grants at the end of this article, so keep reading to learn more! 

Local Programs 

Your local municipality may offer some form of incentive, financial assistance, or waivers that aid in financing your ADU. Some towns or counties have specific housing funds set up to support affordable housing, a category that ADUs usually fall into. For more specific information, visit your local housing department’s office or website and inquire about available ADU financial assistance. 

7.) Can I Finance A Modular ADU?

If you are purchasing a modular ADU as opposed to constructing one yourself, you may be concerned about how it influences financing. The good news is, modular ADUs can be easily financed, just like pre-fab ADUs or built from the ground up structures.

You can finance your modular ADU with HELOCs, construction loans, a cash-out refinance, or simply pay in cash if you have the funds available. In fact, it may be easier to finance a modular ADU as opposed to a pre-fab ADU because lenders can perceive pre-fab options as personal property (depending on how the ADU is built and installed). 

Modular ADUs from Zook Cabins are all built to local building permanent residency codes, making it easier for lenders to finance them. 

Note: This can depend on the state and county you live in and there is not always a significant difference in financing modular versus prefab ADUs. 

8.) Do I Need Insurance To Finance My ADU Project? 

Curious what role insurance plays in all of this? Well, just like a traditional home, insurance is highly recommended (and usually required) if you want to finance your ADU. Although you are not legally required to purchase insurance, lenders typically require several different types of insurance if you’re attempting to finance any type of ADU, whether detached, attached, or converted. 

The different types of insurance required could include homeowner’s insurance, builders insurance, liability insurance (if not covered in homeowners insurance), and sometimes flood insurance, depending on the area where you live. 

The most important is homeowner’s insurance, which can also cover a wide array of areas, including liability and flood coverage. 

Depending on your current homeowners’ insurance, you may be able to simply add coverage for the ADU onto your policy, but in some cases, you need to purchase a separate insurance policy just for the ADU. Your local insurance agent can offer more guidance on which insurance policy is best for financing your specific ADU. 

9.) Does Financing Or Grants Affect the Way I Can Use My ADU?

Financing options and grants are incredible, but on the other hand, they may influence how you are able to use your ADU, particularly if you are relying on government programs or subsidized loans.

For example, if you are accepting a state grant from Vermont, you will be required to rent out the ADU for 5+ years at a fair market price. Other ADU grants like the ones offered by CalHFA in California or the Plus One ADU Program in New York come with restrictions on usage, stating that the ADU must be rented to low or moderate income tenants, designated as affordable housing for a set number of years, or not used as a short-term rental.

This should not discourage you from seeking state grants, but it is an important factor in the financial process. 

Tips for handling the financing and grant process: 

• Carefully read the fine print of your loan and grant agreements to thoroughly understand your limitations, especially regarding rentals.
• Get the advice of a local attorney or real estate agent familiar with ADUs to help guide you through the process.
• Be alert for owner-occupancy clauses that require you, as the homeowner, to be living on the property housing the ADU. 
• Compare ADU financing and ADU grants to see which one aligns with your budget and needs best.

10.) What States Offer Grant Funding When I Want to Finance My ADU?

Not all states are as ADU-friendly as others. However, multiple states recognize the benefits ADUs offer and even have state grants designed to encourage homeowners to invest in ADUs. 

These programs may help homeowners with some of the initial development costs or provide funding to get you started on your journey. If you want to understand which states are the most ADU-friendly, check out our blog that discusses the 7 top ADU-friendly states.

However, if you want to see what states offer state ADU funding, check out the table below.

State ADU Grant Funding
State	New York	California	Vermont	Colorado	New Jersey
Program Name	Plus One ADU Program	ADU Grant Program	Vermont Housing Improvement Program 2.0	ADU Fee Reduction & Encouragement Grant (HB24-1152)	ADU Pilot through Governor Murphy’s budget
Grant Amount	Up to $125,000 (85M state budget)	Up to $40,000	Up to $50,000 per unit	5M state budget with award amount TBD	Up to $100,000 per homeowner (this is a pilot program and not guaranteed to stay)
Eligibility & Notes	Administered through local government and nonprofits; for low/moderate homeowners; multiple municipalities involved	Low and moderate income homeowner-occupied properties	Must rent at/below HUD fair market rates for 5+ years; offered through regional organizations	For low/moderate income homeowners in participating jurisdictions; further details are still pending	Partnered through nonprofits; units must be reserved for ≤80% Area Median Income (AMI) renters for 10 years
More Info	Plus One ADU Program	CalHFA Accessory Dwelling Unit (ADU) Grant Program	Download Application	Denver Colorado’s NEW ADU Program Is Almost FREE!!?🤯 [Don’t Miss Out!]	Push for ‘accessory dwelling units’ to beat housing crunch

Note: It is important to note that other states (Washington, Oregon, Massachusetts, Texas, and New Hampshire) have some local-level funding that varies depending on the local municipality, but no state-wide grant funding. 

Conclusion

Financing ADUs can be a lengthy process, but it doesn’t need to stop you from investing in your dream ADU model. Take the necessary time to research, learn more about your local requirements and available grants, and choose the financing option that best suits your needs. Zook Cabins is happy to help answer any questions you may have about our popular modular ADUs and to guide you in the financing process. Call us today or request a free quote and begin dwelling beyond the ordinary!