How to Finance an ADU in California: Your ADU Financing Options Explained

Building an ADU can create additional living space, provide housing for family members and potentially generate rental income. But before choosing the floor plan or finishes, many California homeowners have a more immediate question:

How am I going to pay for my ADU?

The good news is that you don't necessarily need to have the entire construction cost sitting in your bank account. Depending on your home equity, income, existing mortgage and ADU project, there are several ways to finance an ADU in California.

The challenge is figuring out which ADU financing option makes the most sense for you.

What Are the Main ADU Financing Options?

The most common ways homeowners finance an ADU include:

• Home Equity Line of Credit (HELOC)
• Home equity loan
• Cash-out refinance
• Construction or construction-to-permanent loan
• Renovation financing
• Personal savings or a combination of cash and financing

There isn't one "best ADU loan" for every homeowner. Your best option depends heavily on how much equity you already have and the terms of your existing mortgage.

1. Using a HELOC to Finance an ADU

A HELOC for an ADU is one of the first options many homeowners consider.

A Home Equity Line of Credit allows you to borrow against some of the equity you've accumulated in your home.

Unlike a conventional loan where you receive the entire amount at closing, a HELOC generally provides a line of credit that you can draw from as money is needed.

That structure can work particularly well for construction because ADU expenses occur over time.

You may need money for design and engineering first, followed by permits, site preparation, fabrication, construction and finishes.

Instead of borrowing the entire amount on day one, you may be able to draw funds as the project progresses.

Why homeowners consider a HELOC for ADU construction

A HELOC may allow you to:

• Keep your existing first mortgage in place
• Borrow against existing home equity
• Draw money as construction progresses
• Pay interest primarily on the amount you've actually borrowed

The tradeoff is that HELOC interest rates are generally variable, so your borrowing cost can change over time.

2. Home Equity Loan for an ADU

A home equity loan also uses the equity in your property, but it works differently from a HELOC.

Instead of having a revolving credit line, you typically receive a lump sum and repay it over a defined period.

For homeowners who know approximately how much their ADU will cost, the predictability of a fixed-payment loan may be attractive.

The basic distinction is:

• HELOC: Flexible line of credit, generally variable rate.
• Home equity loan: Lump-sum borrowing, often with a fixed rate.

Both allow qualifying homeowners to tap the value already accumulated in their property without necessarily replacing their existing first mortgage.

3. ADU Construction Loans

An ADU construction loan can be useful when available home equity isn't sufficient to fund the entire project.

Construction financing is different from a conventional mortgage because the lender may release funds through a series of construction draws rather than providing all the money upfront.

Some construction and renovation financing programs can also consider the anticipated value of the property after the ADU is completed.

This can potentially help homeowners who have a good ADU project but don't have enough accessible equity to pay for the entire build.

Construction loans can involve more documentation, inspections and lender oversight than a HELOC, so it's important to understand the draw process before selecting a lender. If you want to understand the broader build process, Metricon's ADU how-it-works page gives a useful overview.

4. Cash-Out Refinancing to Build an ADU

A cash-out refinance for an ADU replaces your existing mortgage with a new, larger mortgage and gives you the difference in cash.

For example, imagine that your home has appreciated substantially since you purchased it. A qualifying homeowner might refinance the property and use a portion of that accumulated equity to fund the ADU.

But there's an important consideration.

If you currently have a low mortgage rate, refinancing your entire mortgage at today's rate could significantly change your monthly payment.

This is one reason many homeowners compare a cash-out refinance with a HELOC or second mortgage before making a decision.

CalHFA's own analysis of ADU financing identified this issue when rates increased: homeowners with historically low first-mortgage rates became less interested in construction financing that required refinancing that mortgage.

5. Renovation Loans

Certain renovation mortgage programs can finance improvements as part of a larger mortgage transaction.

Examples can include Fannie Mae HomeStyle and FHA 203(k) financing, subject to program and lender requirements.

These products can be more complicated than simply opening a HELOC, but they may be worth exploring for homeowners whose financing situation doesn't fit conventional home-equity borrowing.

What About the $40,000 California ADU Grant?

You may find older articles online advertising a $40,000 California ADU grant.

Be careful when planning around this money.

The California Housing Finance Agency states that all funds for its ADU Grant Program were fully reserved as of December 28, 2023. Program information remains online for grants already in the pipeline, but homeowners should not assume the grant is currently available.

Check current state and local programs before incorporating any grant into your ADU budget.

Can Rental Income Help Pay for an ADU?

This is where ADU financing becomes particularly interesting.

An ADU isn't simply another home improvement. A legal ADU may potentially produce rental income. Metricon's ADU FAQs also covers the homeowner and investor benefits of building one.

Suppose an ADU costs $250,000 to build and generates $2,500 per month in rent.

That's $30,000 in potential gross annual rental income before vacancy, financing costs, insurance, property taxes, maintenance and other expenses.

The relevant question therefore isn't simply:

"What does my ADU cost?"

It's also:

"What does my ADU cost after considering its potential income and value?"

Metricon's ADU Rental Return Calculator was created to help homeowners examine exactly these variables. You can enter construction cost, financing assumptions, estimated monthly rent, vacancy, taxes and insurance to estimate potential operating income and cash-on-cash returns.

Will an ADU Increase My Property Taxes?

Usually, yes, but California homeowners should understand an important distinction.

Building an ADU generally results in the new construction being assessed, rather than automatically resetting the Proposition 13 assessment of your entire existing home.

The actual added assessment is determined by the county assessor.

Metricon's ADU Value & Tax Calculator allows homeowners to estimate construction cost, potential ADU value and the possible annual property-tax increase before moving forward with a project.

Don't Look at the Loan in Isolation

When evaluating ADU financing options in California, look at the entire investment.

Consider-

Construction cost + financing cost + additional taxes + insurance + expected rent + potential increase in property value.

A loan with a slightly lower monthly payment isn't necessarily the best choice if it substantially increases total interest expense.

Likewise, a higher construction cost could potentially make sense if the finished ADU commands more rent or creates substantially more property value.

The numbers should be evaluated together.

Start With Three Numbers

Before speaking with an ADU lender, determine:

• Approximately what will the ADU cost?
• How much equity do you have in your existing home?
• What could the completed ADU potentially rent for?

Those three numbers provide a much better starting point for comparing financing alternatives.

Calculate Your ADU Before You Build It

Metricon Homes provides online tools to help homeowners evaluate the financial side of an ADU before making a construction decision.

Use our ADU financing calculator to explore monthly financing costs, our ADU Value & Tax Calculator to estimate value and property-tax impact, and our ADU Rental Return Calculator to evaluate potential rental returns.

Understanding the economics of your ADU before you build it can be just as important as choosing the right floor plan.

Explore your ADU financing options and speak with one of Metricon's lender partners.