Construction Loans vs. Personal Loans for ADUs: What Do California Homeowners Need to Know?

What Is an ADU?

An Accessory Dwelling Unit (ADU) is a small, self-contained residential unit built on the same lot as a primary residence, complete with its own kitchen, bathroom, and private entrance. Often called granny flats or internal ADUs, these spaces can take the form of detached backyard cottages, attached additions, basement apartments, or garage conversions—depending on local zoning laws and building permits required by California municipalities. ADUs have grown rapidly in California, with San Diego permitting 5,720 ADUs between 2021–2024 (The National Law Review). And because these projects typically cost $100,000 to $400,000+ to build, most homeowners rely on financing options such as construction loans, personal loans, or home equity lines of credit to complete the work (Shelterforce).

When defining an ADU, emphasize ‘self-contained living’ and note that smart space planning (like combined bath/laundry zones) is what makes small units feel complete.

Construction Loans vs. Personal Loans: What’s the Difference?

What Is a Construction Loan for an ADU?

A construction loan for an ADU is a short-term form of construction financing secured by real estate and based on your home’s future appraised value once the ADU is completed (NerdWallet). Funds are released in phases as work progresses, and the loan typically converts to a long-term fixed-rate loan after construction. These loans offer higher borrowing power but require detailed building plans, architectural designs, and a licensed construction contractor who follows California Building Code and local zoning regulations. Construction loans are often interest-only during the build, making them useful for larger ADU projects or multi-generational living setups.

Key Insight: “These mortgages have an advantage over borrowing from equity: They let you borrow more. That’s because the loan amount is based on the projected value of your property after the ADU is ready for occupancy… In contrast, the amount you can borrow in an equity loan or HELOC is based on the home’s value before the work is done.” — Holden Lewis, NerdWallet.

What Is a Personal Loan for ADU Construction?

A personal loan is an unsecured loan that can be used for ADU construction, often ideal for smaller upgrades like converting a garage into a home office or finishing an internal ADU. These loans typically come with higher interest rates and lower borrowing limits, most commonly capped at $50,000–$100,000 (Otto ADU). Because lenders focus on credit, Household Income, and debt—not home equity—personal loans avoid the need for permits, soil tests, or contractor agreements required for larger projects. They also often include origination fees and shorter repayment timelines.

Additional Insights:

• The average personal loan APR is 12.25% as of 2025 (Bankrate).
• These loans offer fast approval and work well as gap funding, but repayment terms are typically 5–7 years, making them best for modest ADU improvements or lower-cost builds.

Think of personal loans as gap funding: great for sub-$100K needs, but costly to carry for a full ADU build.

ADU Costs in California: Why Financing Is Necessary

Building an ADU in California is typically a six-figure project, which is why most homeowners need financing to complete construction. Shelterforce reports that “total cost estimates start around $100,000 for an attached conversion project and soar to as much as $400,000 (or far more) for a high-end detached new build” (Shelterforce). Expenses often include architectural design, site preparation, building permit applications, energy reports, and compliance with local building codes set by California municipalities. Even though impact fees are waived for ADUs under 750 sq. ft., the overall investment still leads many homeowners to rely on construction loans, cash-out refinancing, or a Home Equity Agreement to cover costs. Rising interest rates in 2024–2025 make affordability more challenging, making it essential to choose the right financing strategy based on loan-to-value considerations and lender policies.

Budget six figures before you pick a loan—site conditions, utility runs, and permit fees can swing total ADU cost more than finishes.

Which Is Better for Building an ADU: Construction Loan or Personal Loan?

The best loan for building an ADU depends on your project size, home equity, and overall credit profile. Construction loans are often preferred for larger projects because they’re based on the future property value once the ADU is finished (NerdWallet). Personal loans, on the other hand, are typically used for smaller ADU projects or upgrades, though they come with higher interest rates and lower borrowing limits (Otto ADU).

When a Construction Loan Is Better

A construction loan is generally the stronger option for a full-scale ADU ranging from $150,000 to $400,000+, whether you’re adding space for housing for family members or creating an income-producing rental next to the main house. Because these loans rely on the projected value of the home after completion, they offer greater borrowing power—an advantage supported by NerdWallet’s Holden Lewis, who explains that construction loans “let you borrow more… based on the projected value of your property after the ADU is ready”. They also typically offer lower long-term payments, converting into a fixed mortgage over 15–30 years and reviewed by residential loan officers who follow local municipalities’ requirements.

Best For:

• Large ADU builds ($150K–$400K+)
• Homeowners needing a higher loan amount tied to future value
• Lower long-term monthly payments
• Projects requiring full plans, permits, and a licensed contractor

When a Personal Loan Is Better

A personal loan is often the right choice for smaller ADU upgrades, like a Home Office ADU, interior finishes, or partial garage conversions under $100,000. Since these loans require no home equity, they’re ideal for homeowners who want quick access to funds without navigating construction inspections or lender policies connected to local building offices. However, personal loan rates are significantly higher—averaging 12.25% APR as of 2025 (Bankrate)—and include short repayment terms, making them more suitable for modest projects rather than full ADU builds.

Best For:

• Small ADU projects or finishing work under $100K
• Homeowners needing fast, paperwork-light financing
• Situations with no available home equity
• Borrowers planning to refinance later using a HELOC or other option

Use this comparison moment to remind readers: larger ADUs usually need future-value financing, so a construction loan often unlocks more budget than unsecured options.

Interest Rates: Construction Loan vs. Personal Loan (2025 Data)

Current Construction Loan Rates

Construction loan rates for ADUs in 2025 typically range between 6.25% and 9.75% APR, according to data from True Built Home. These loans often feature interest-only payments during the construction phase, which helps keep costs manageable while the project is being built. Once the ADU is complete, the loan usually converts into a long-term fixed mortgage, historically landing in the 4%–7% interest range depending on market conditions.

Current Personal Loan Rates

Personal loans—while faster and easier to obtain—come with significantly higher interest. As of late 2025, the average personal loan APR is 12.25% (Bankrate), with higher rates for borrowers with lower credit scores. Because personal loans are unsecured, terms are shorter and interest costs are higher. Additionally, personal loan interest is not tax-deductible, which increases the overall cost of financing an ADU.

Tax Differences

A key financial distinction is the tax treatment of interest. Construction loans and mortgage-based financing may offer tax-deductible interest when the funds are used to “substantially improve” the home—such as building an ADU—subject to IRS rules. In contrast, personal loan interest is not tax-deductible, as clarified by Experian (Experian). This distinction often makes construction and home-equity–based financing more cost-effective over time.

Tie rate talk to real outcomes: a lower construction-loan APR can materially improve long-term cash flow if the ADU will be rented or used for multigenerational living.

How to Qualify: Construction Loan vs. Personal Loan

Construction Loan Requirements

Qualifying for an ADU construction loan is more rigorous because lenders underwrite both you and the project. Most lenders look for a credit score of 680+, a debt-to-income ratio (DTI) below ~45%, and stable, documented income. You must also provide detailed construction plans, permits, and a signed contract with a licensed contractor. A key requirement is an appraisal based on the future value of your home after the ADU is built.

Personal Loan Requirements

Personal loans are easier to qualify for because they rely solely on the borrower’s financial profile, not the construction project. To access higher loan limits—often up to $50,000–$100,000—lenders typically prefer a credit score of 720+ and strong income. Unlike construction loans, no plans, permits, contractor agreements, or appraisals are required, making personal loans a faster but more expensive financing option for ADUs.

Qualification depends on documentation: highlight that construction loans require plans, permits, and contractor bids, while personal loans rely mostly on income and credit.

California & San Diego ADU Financing Programs

San Diego Housing Commission (SDHC) ADU Loan Program

San Diego offers one of the most robust local ADU financing options through the San Diego Housing Commission (SDHC). The program provides up to $250,000 in funding for eligible homeowners, with 1% interest during construction and a 4% fixed rate after the ADU is completed. Participants must agree to a 7-year affordability covenant, typically requiring the ADU to be rented at affordable rates. As the California Department of Housing & Community Development notes, this program “provides financing to eligible property owners” to encourage ADU development that expands affordable housing in San Diego. This makes SDHC one of the most accessible and cost-effective ADU loan options available statewide.

Other California Programs

Beyond San Diego, several regions across California offer additional ADU financing pathways:

• City of Clovis ADU Loan Program – Offered in partnership with Self-Help Federal Credit Union, this program provides low-interest ADU loans to expand housing options for local residents.
• Housing Trust Silicon Valley ADU Programs – Provides funding to Bay Area homeowners seeking to build ADUs, with a focus on affordability and equity-based lending.
• Fee Waivers & Impact Fee Exemptions – Statewide, California waives impact fees for ADUs under 750 sq. ft., significantly reducing upfront cost burdens for homeowners.

These local and state-level programs reflect California’s push to streamline ADU development and make financing more accessible—especially in high-cost markets like San Diego, Los Angeles, and the Bay Area.

Check local ADU programs early; some require income limits or affordability terms that affect your rental plan and timeline.

Alternatives to Construction and Personal Loans

Home Equity Loan or HELOC

A home equity loan or HELOC is one of the most cost-effective ways to finance an ADU because rates are typically much lower than unsecured personal loans. HELOCs offer flexible, variable-rate borrowing based on the homeowner’s existing equity. According to Experian, “HELOC interest is tax deductible, although you can only deduct HELOC interest when you use the funds to substantially improve your home, among other requirements.” (Experian)

Cash-Out Refinance

A cash-out refinance replaces your existing mortgage with a larger one, allowing you to pull out equity to fund your ADU. This option works best when interest rates are favorable, as it provides long-term, stable payments. However, many California homeowners are currently avoiding cash-out refinances because refinancing would force them to give up low-rate mortgages secured prior to recent rate hikes.

Renovation Loans (FHA 203k, Fannie Mae HomeStyle)

Renovation loans are government-backed or conventional mortgage products that allow homeowners to finance improvements—including ADUs—into a single loan. Products like FHA 203k and Fannie Mae HomeStyle base the loan amount on the after-renovation value, helping borrowers access more capital. The tradeoff is additional paperwork, inspections, and lender oversight, which makes these loans more complex than traditional financing.

Grants & Subsidies

California has introduced several grant and subsidy programs to encourage ADU development:

• The CalHFA ADU Grant, which offered $40,000 for pre-development costs, is now fully allocated—but may reopen depending on future state funding cycles.
• Several counties, such as Santa Cruz, offer forgivable ADU loans when the homeowner agrees to rent the ADU at affordable rates for a set period.
• The California HCD continues to support local jurisdictions offering ADU incentives, making it worthwhile for homeowners to check for city- or county-level opportunities.

These alternatives—especially equity-based and renovation financing—can offer lower rates and better long-term savings than personal loans, depending on the homeowner’s equity and financial profile.

If you have strong equity, compare HELOCs or cash-out refis first—they often beat personal loans on total interest over time.

Expert Insights on ADU Financing

Expert research consistently shows that financing remains one of the biggest barriers to ADU development in California. According to Shelterforce, “Most homeowners have neither the capital nor credit to self-finance an ADU… If financing doesn’t change, ADUs will stay niche and expensive,” underscoring why loan accessibility is critical for expanding ADU production statewide.

Source: Shelterforce

Denise Pinkston, President of the Casita Coalition, emphasizes the need for underwriting reform, stating that “Federal lenders must allow future ADU income to size loans… or risk re-redlining.” This highlights a major policy challenge: borrowers often cannot qualify for ADU loans because lenders do not count rental income from the planned unit.

Source: Shelterforce

Housing expert Laurie Goodman of the Urban Institute further explains why ADU loan access remains limited, noting that “Homeowners must navigate complicated and expensive planning requirements… if they can even find a willing lender.” These structural obstacles often discourage homeowners attempting to finance ADU construction through traditional lenders.

In the expert section, reinforce that lenders favor ADUs designed for real usability (privacy, light, storage), because proven rentability supports stronger financing cases.

Source: Shelterforce

Step-by-Step: How to Choose the Right ADU Loan

Choosing the right ADU loan in California requires understanding your project scope, finances, and available lending options. Follow these steps to make an informed decision and secure the best financing for your ADU:

1. Estimate Your Total ADU Cost
Start by calculating expected construction expenses. ADU projects in California typically range from $100,000 to $400,000+, depending on size, design, site prep, and materials. As Shelterforce notes, ADU development is generally a six-figure project due to design, permitting, labor, and material costs.

2. Check Your Home Equity & Credit Profile
Determine how much equity you have and review your credit score. Construction loan lenders often prefer 680+, while personal loans offering higher limits typically require 720+. Your equity and credit will determine whether you qualify for construction loans, HELOCs, or unsecured loans.

3. Compare Construction Loans, Personal Loans & HELOCs

Evaluate the pros and cons of each option:

• Construction Loans: Allow borrowing based on future home value (NerdWallet) and offer lower long-term payments.
• Personal Loans: Faster approvals but higher APRs (~12.25% on average).
• HELOCs: Lower rates than personal loans; interest may be tax-deductible when used for home improvement.

4. Get Pre-Approved
Speak with lenders—preferably those with ADU experience—to understand borrowing limits, rate estimates, and qualification requirements. Pre-approval helps you determine whether the loan aligns with your ADU budget.

5. Finalize Your ADU Plans
Construction lenders require detailed architectural plans, a contractor agreement, and permit readiness. These documents also help appraisers determine the after-construction value of your home.

6. Complete the Appraisal
For construction and renovation loans, lenders order an appraisal based on the projected value of your home after the ADU is built. This directly impacts your borrowing capacity.

7. Secure the Loan & Begin Construction
Once approved, funds are disbursed in stages—typically called draws—throughout construction. After the ADU is completed, construction loans usually convert to a permanent mortgage, personal loans begin standard repayment, and HELOC users start repaying what they’ve drawn.

Conclusion: Which Loan Should You Choose for Your ADU?

The best ADU loan depends on your budget, equity, and project size. A construction loan is ideal for full builds costing $150K–$400K+, especially when you need to borrow against your home’s future value and want long-term, lower monthly payments. A personal loan works better for smaller projects under $100K, quick funding needs, or situations where you have little or no home equity—but expect higher interest and shorter repayment terms.

Alternatives such as HELOCs, cash-out refinances, and renovation loans often offer lower rates and tax advantages, making them strong options for qualified homeowners. San Diego residents may also benefit from local solutions like the SDHC ADU loan program, which provides low-interest support for eligible homeowners.

Before choosing, speak with lenders experienced in California and San Diego ADU financing. Their familiarity with local permitting, appraisal rules, and loan structures can help you select the most cost-effective path for your project.

Match the loan to your scope: full builds usually need future-value financing, while smaller conversions can justify faster options.