How to Finance Your ADU in 2021

7/23/21

Home Equity Line of Credit (HELOC)

  • A line of credit secured by your home that gives you a revolving credit line to use for large expenses or to consolidate higher-interest rate debt on other loans. A HELOC often has a lower interest rate than other types of loans. 
  • Borrow against the available equity in your home w/ your house used as collateral for the line of credit. You can borrow as little or as much as you need throughout your draw period (usually 10 years) up to the credit limit established at closing. At the end of the draw period, the repayment period (usually 20 years) begins. 
  • Minimum loan amount is generally $25,000 but lines as low as $15,000 are available in different locations.
  • Maximum amount is generally $1,000,000
  • APR will not exceed 24% or go below 1.99%
  • Combined amount for all third-party fees generally range from $452 to $2,295 for a $50,000 line of credit and $452 to $3,320 for a $100,000 line of credit
  • To qualify for a HELOC, need to have available equity in your home (amount you owe must be less than the value of your home). 
  • You can typically borrow up to 85% of the value of your home minus the amount you owe. 
  • Lender typically looks at your credit score and history, employment history, monthly income and monthly debts.
  • Variable interest rates are typically used for HELOC’, meaning the rate can change from month to month. The rate is calculated by an index and a margin. The index that is used by most banks is the U.S. Prime Rate as published in the Wall Street Journal. The margin is constraint throughout the life of the line of credit. 
  • Some lenders do allow an option where you can convert a portion of the outstanding variable-rate balance on your HELOC to a fixed rate. 
  • Source: Bank of America

Cash-Out Refinance

  • Pays off your existing first mortgage. This results in a new mortgage loan which may have different terms than your original loan (= different loan and/or different interest rate and/or payment schedule)
  • Gives you a lump sum when you close your refinance loan. The loan proceeds are first used to pay off your existing mortgage(s) , including closing costs and any prepaid items (real estate taxes or homeowners insurance), any remaining funds are yours to use as you wish.
  • Available through either fixed-rate mortgage or an adjustable-rate mortgage. 
  • Closing costs similar to your original mortgage. These are typically 3-6% of the loan amount and rolled into the mortgage. This 3-6% charge is on the entire amount of the mortgage, not the loan amount. So if you owe $150,000 on your mortgage and use a cash-out refinance to borrow another $50,000, you’re paying closing costs of 3-6% on the entire $200,000.
  • Lenders will generally allow you to go as low as 20% equity in your home after refinancing (though some will go lower). 
  • Source: Mortgageloan.com

Construction loans

  • Short-term, higher interest loan that provides funds to build a residential property. 
  • Usually one-year in duration during which time the property must be built and a certificate of occupancy issued.
  • Can be used to cover the cost of the land, contractor labor, building materials, permits and more
  • Usually include a ‘contingency reserve’ to cover unexpected costs that could arise during construction.
  • Home furnishings aren’t covered w/in a construction loan, permanent fixtures like appliances and landscaping can be included.
  • Typically have variable interest rates that move up and down w/ the prime rate. Typically higher rates than traditional mortgage loan rates. Loan is unsecured by your home, so they tend to view these loans as bigger risks. 
  • Must provide lenders w/ a construction timeline, detailed plans and a realistic budget. 
  • Once approved, borrower is put on a draft (or draw) schedule that follows the project’s construction stages, typically expected to make only interest payments during the construction stage. The lender pays out the money in stages as work on the new home progresses. Borrowers are typically only obligated to repay interest on any funds drawn to date until construction is completed. 
  • While the home is being built, the lender has an appraiser or inspector check the house during the various stages of construction. If approved by the appraiser, the lender makes additional payments to the contractor, known as “draws”. 
  • There are three types of construction loans:
    1. Construction-to-permanent: Provides the funds to build the dwelling and for your permanent mortgage as awell. You borrow money to pay for the cost of building your home, and once the house is complete and you move in, the loan is converted to a permanent mortgage. Main benefit of this approach is you only have one set of closing costs to pay, reducing your overall fees. Once it becomes a permanent mortgage, typically loan terms for 15 to 30 years, then you make payments that cover both interest and the principal. 
    2. Construction-only loan: Provides the funds to complete the building of the property, but the borrower is responsible for either paying the loan in full at maturity (typically 12 months or less) or obtaining a mortgage to secure permanent financing. Borrower is only responsible for interest payments on the money drawn at the time. Loan rates are almost always tied to the prime rate plus a margin. Additionally, they have a higher rate than traditional mortgages. 
    3. Owner-builder construction loan: Construction loans where the borrower also acts in the capacity of the home builder. Most lenders won’t allow the borrower to act as their own builder because of complexity of constructing a home and experience required to comply w/ building codes. Lenders that allow it only allow if it the borrower is a licensed builder by trade. 
  • Requirements:
    • Had plans and specifications drawn and negotiated a contract w/ a builder reflecting the total cost to build so that a loan amount can be established
    • Lenders review a borrower’s employment history, savings, income stability and ability to repay the loan in addition to a thorough review of the plans and specifications. 
    • Qualifications include: Good to excellent credit, stable income, low debt-to-income ratio, down payment of at least 20%
  • Source: Bankrate.com

Cash

  • The easiest & most streamlined path is to bring existing capital to the table. This is out of the question for most homeowners – but if you can bring cash to finance a project you will be able to start the project sooner than most and won’t worry about paying off another lender.

Home Renovation Loan (CalHFA $25k ADU Grant)

Conventional Renovation program allows
you to borrow the necessary funds to build
either a system built or site-built ADU with one
cost-effective home loan. You can purchase
or refinance a single-family primary residence
to both build an ADU and/or make home
improvements and renovations.

CalHFA has also recently launched an ADU grant program that allows for you to pay for up to $25k from the project costs. This must go through an approved vendor, like Land Home Financial Services, but is available for homeowners that fall under CalHFA’s ‘low-income or moderate income in a low-income area’ qualification.

There are 3 separate categories you can qualify under.:

  1. If they are under Fannie’s 80% AMI they are eligible. Fannie Mae termsheet below: https://www.calhfa.ca.gov/homeownership/programs/termsheet-adu.pdf
  2. If you are below CalHFA’s income limit (see link above) AND in a census tract area.
  3. If you are below CalHFA’s income limit AND your LTV is higher than 80% they are eligible.

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