ADU Guide | What is an ADU? Rules and ADU funding options

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The rise of annexes

Granny flats, in-laws’ apartments, backyard cottages, coach houses… whatever you call them, Accessory Living Units (ADUs) can provide more living space or an additional income stream.

They can also help with the ongoing shortage of available and affordable housing – particularly in densely populated cities where land is limited.

But building an ADU is different from a house and comes with its own set of rules and restrictions. Before you jump in, it’s important to know your local zoning regulations, what loan types are best, and if you’re eligible for a $40,000 ADU grant.


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What is an ADU?

Accessory dwelling units (ADUs) are a secondary type of dwelling structure on a lot that already has a house on it. They must have a separate entrance, kitchen, bathroom and living space from the main house.

ADUs come in a variety of forms, e.g. B. as garage conversions, standalone structures in the backyard, or as an addition or converted part of the existing home.

Families often use ADUs to create separate living solutions for multiple generations on a single property while maintaining autonomy. They can also be rented out as an additional source of income for homeowners.

“The most common use is by home hackers or more savvy investors looking to generate steady streams of income from a primary residence,” he said Kerron Stokes, President and Co-Founder of the Resource Group at RE/MAX Leaders. “ADUs address many additional issues, including security, privacy, land use, and income based on resident occupancy. This has become a major problem for many cities that have restricted AirBnB.”

Where can ADUs be built?

California and Oregon are the only two states that will have blanket ADU legalization for all residential areas as of July 2022. New York is working to pass the same statewide bills as California.

“We’ve seen more than 50 major metropolitan areas pass ADU ordinances to try and ease some of the burden of home buying. Typical cities that are growing fast and struggling with affordability.”

-Caitlin Bigelow, CEO and co-founder of Maxable

“Moreover, it depends on the local jurisdiction you live in. There are fantastic ADU ordinances in Austin, Houston and San Antonio, Texas. There are some great ordinances in Colorado, but it’s all dictated at the local level,” he said Caitlin BigelowCEO and co-founder of Maxable, an ADU marketplace and data provider.

“We’ve seen more than 50 major metropolitan areas pass ADU ordinances to try and ease some of the burden of home buying. Typical cities that are growing fast and struggling with affordability.”

How do I find my local ADU regulation?

If your location allows ADUs to be built and you want that to happen, the rules around them should be relatively easy to find. According to Bigelow, the best way is to search your city’s website.

It’s usually a good sign if the website has an ADU summary. But if you end up digging through hundreds of pages of municipal bylaws, it probably indicates that your locale isn’t ADU-friendly.

“Zoning and rising building costs are the biggest challenges facing ADUs,” Stokes said. “Consumers need to exercise thorough diligence when considering a property for this use. Elevation requirements, utilities, building codes, easements, and tax zones can ultimately impact the construction and use of the property.”

How to fund an ADU

ADU loan options differ from regular home loans because they are not intended as a primary residence. However, borrower decisions are still similarly dependent on the interest rate environment.

Overall, about 62% of borrowers paid for their ADU with cash and 43% used a mortgage, so a 2021 UC Berkeley Terner Center for Housing Innovation survey of over 800 California homeowners. Using cash is more common, as ADUs are often made for older family members who may have just sold their homes and are pooling their funds.

Of those who took out a mortgage, 56% chose a HELOC or home equity loan, 35% did a cash payout refinance, and 6% took out a home improvement or home loan.

ADU mortgage type % of homeowners (CA)
HELOC/Home Equity Loan 56%
Cash-out refinancing 35%
Renovation or building loan 6%

“When we saw historically low interest rates last year and the year before, everyone did a cash-out refinance. Now people are much more inclined to do a HELOC because they don’t want to touch their existing interest rates,” Bigelow said.

“The other method is home improvement loans, which aren’t a good option if you don’t want to touch your primary mortgage. I don’t see these being very popular this year, they really were only a good choice if you didn’t have equity to start with. And the last option is that people can pay cash.”

Fannie Mae and Freddie Mac’s new ADU rule

An important development for ADUs is coming at the federal level. Fanny Mae and Freddie Mac Homeowners can now qualify for a loan based on their future projected ADU rental income.

Previously, you couldn’t use potential ADU income for mortgage qualification — even if you did your homework and calculated hypothetical monthly rent based on market rates.

“People who were building ADUs typically either had a lot of equity in their homes or they had cash to fall back on,” Bigelow said. “With the launch of this new program, there will be a whole new subset of borrowers who previously would not have qualified for a loan who now qualify because rental income can be counted.”

ADU Scholarship Programs

Before looking at the financial options for your ADU, it’s a good idea to check if your area offers grant programs. These programs can be found in several cities across the country, and may emerge in many more as a stimulus to strengthen the housing stock.

In 2022, the California Housing Finance Agency announced a $100 Million budget for $40,000 in individual ADU grants for residents. You have to come under the income qualifications, but they’re pretty high. For example, in Santa Clara County, you can make up to $300,000 a year and still qualify.

“It’s not a loan. It does not have to be paid back. It’s literally free money. That $40,000 can be used for all of the project’s soft costs,” Bigelow said. “There could be design and permit fees. And if your design and permitting fees don’t exceed $40,000, which most of them probably won’t, then the rest of that grant can be used to pay the interest on the loan you took out. We are really excited about the potential this opens up for people.”

Can ADUs help the inventory shortage?

Perhaps the biggest problem facing the US housing market is the ongoing shortage of homes for sale. The imbalance between supply and demand caused by low inventories is the main reason behind the rising property prices we have seen over the past two years.

While ADUs won’t solve the problem, increasing their numbers and making their construction more accessible would certainly help.

“ADUs will not be the magic bullet that solves our housing crisis. But they are one of the most viable ways to increase the housing stock.”

-Caitlin Bigelow, CEO and co-founder of Maxable

“ADUs will not be the magic bullet that solves our housing crisis. But they’re one of the most viable ways to increase the housing stock,” Bigelow said. “But housing policy in general is very, very controversial. And when you see the state trying to step in and push through legislation that would be able to really alleviate the housing crisis, those bills are almost unanimously rejected.”

But as Fannie Mae’s new rule might suggest, the tide seems to be turning in favor of federal ADU policy.

on feetb. The White House held its first conference on Jan how to encourage ADU growth nationwide. Susan Rice, the Biden administration’s domestic policy adviser, said she believes ADUs are the best way to boost the current US housing stock.

California ADU model

The Golden State is home to some of the least affordable, most densely populated and most desirable housing markets in the country. These factors also make it a place in dire need of more available housing.

California has passed several laws relaxing ADU rules to make construction easier and faster. Since 2017, the state has passed six bills to streamline ADU construction and remove common hurdles borrowers have faced.

“The state has abolished home ownership [requirements]. The state has abolished the minimum lot size requirements. They mandated a four-foot maximum lateral and rear setback,” Bigelow said.

“ADUs must now be legally banned in HOAs, so it overrides all local CC&Rs [covenants, conditions, and restrictions] within a neighborhood. And they’ve eliminated development and impact fees. As a result, more than 20,000 ADUs have been built in California in recent years in response to these changing regulations.”

From 2018 to 2020, a total of 33,881 ADUs were allowed to be built and 22,695 were completed, according to the California Department of Housing and Community Development.

Year ADUs allowed ADUs built
2018 8,957 5,930
2019 12,532 7,808
2020 12,392 8,957

ADU advice for borrowers

If you’re considering building an ADU, the first thing you need to do is figure out if it makes financial sense for you.

Building one to rent out doesn’t necessarily mean you’re just looking at the upfront costs, but also your monthly cash flow, Bigelow advised. For example, if you fund a $100,000 ADU and have monthly loan payments of $600, estimate how much a modern studio in your neighborhood would rent.

“You can get anywhere from $1,200 to $3,000 a month for that in most parts of California. While the starting price can be scary, the financial benefits are very, very compelling,” Bigelow said.

She also encourages homeowners to explore their contractor and designer options before hiring anyone.

What are mortgage rates today?

If you’re ready to break the ground and add more living space to your property, great! Your next step is to explore local ADU laws and the best way to get funding — even if you plan to pay for it in cash.

As always, consult your real estate or credit professional with questions and learn what interest rates you qualify for.

The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for the products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policies or position of Full Beaker, its officers, parent companies or affiliates.

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