The Ultimate Guide to ADU Financing in San Diego

How to Finance an ADU in San Diego

After working with dozens of clients with varied financial backgrounds on all types of ADU projects, we typically see homeowners utilize 3 key financing methods: loans from a financial institution, government grants, and personal savings. Some homeowners finance their ADU projects using one of these methods, and others use a combination.

Home Equity Line of Credit (HELOC)

A home equity line of credit, also called a HELOC, is one of the more popular loans taken to finance an ADU build. A HELOC allows homeowners to borrow against the equity in their home.

For example: Your home is worth $800,000, and you currently have $400,000 left on your mortgage. That means you have $400,000 in home equity. Financial institutions will allow you to borrow a certain percentage of this equity – sometimes even as much as 80-90%. In the example we just gave, a homeowner with

$400,000 in equity may be able to receive financing through a HELOC for as much as $360,000.

The terms with equity loans are often flexible, though the interest rates associated with them are often variable, meaning they can fluctuate with the housing market. Sometimes, these variable loans can be converted to a fixed rate, but it depends on your credit score and your financial institution. In any case, the interest rate should be discussed with your financial advisor before taking out a HELOC.

A HELOC offers flexibility for incremental ADU funding, but variable interest rates should be considered when planning repayment.

Cash-Out Refinance

HELOCS are ideal for homeowners who have a lot of equity in their existing house. But if you don’t– maybe you have only been living in it for a few years, for example — you may consider funding your ADU through a cash-out refinance.

With a cash-out refinance, you’re essentially taking out a new mortgage on your house for a higher amount than you previously owed. The difference between your original, lower mortgage and your newer, higher mortgage will be what you use to build your ADU.

For homeowners also looking to refinance their existing mortgage, this solution can be ideal. However, it’s important to note that today’s interest rate may also be higher than the interest rate on your original mortgage, which could result in a higher monthly mortgage. If you plan to use your ADU as a rental unit, these costs can be offset.

Cash-out refinancing is ideal for consolidating mortgage and ADU costs but requires careful evaluation of interest rates and monthly payments.

Construction Loans

Construction loans can also be an appealing option for homeowners without much equity in their homes. Unlike a mortgage, construction loans are not given as a lump sum. Instead, a homeowner takes “draws” from the loan as needed. Generally, these draws are given at certain construction milestones to ensure the money is being put toward the construction process.

During construction, a homeowner will make interest payments on the loan but will not be responsible for paying back the principal until after the construction has ended.

After construction, the loan often converts to a traditional mortgage, which then replaces your current mortgage. This new mortgage can have a fixed rate or an adjustable rate.

Construction loans offer flexibility with milestone-based funding, making them ideal for structured ADU projects.

Fixed Rate Second Loan

Fixed-rate second loans are an attractive financing option for homeowners who have a good credit score and want a predictable monthly loan payment but perhaps do not have a lot of existing equity in their home.

While HELOCs offer you loans based on your home’s current equity, fixed-rate second loans offer you loan amounts based on the estimated value of your property after project completion. For example: you only have $50k in equity in your existing home, but after building an ADU, your property value is expected to increase by $200k. A fixed-rate second loan takes this into consideration when deciding how much money to lend.

These loans are not a refinance of your existing mortgage, so if you are enjoying a low interest rate on your current financing, you will continue to do so after the loan. These second loans are merely a tack-on to your existing monthly payment at a fixed rate, meaning it will not change over time as the market fluctuates.

Fixed-rate second loans provide predictable payments without refinancing your primary mortgage, ideal for controlled budgeting.

Renovation Loan (203K or Homestyle)

Renovation loans are a loan option that allows homeowners to finance the purchase of their home with the cost of its renovation, which can include an ADU build. If you’re a homeowner who is buying a single-family home because the lot can support an ADU rental property or guest house, you can buy the home using a renovation loan. This will not only let you close on the house but also allow you to begin construction on the ADU right away.

You may also see renovation loans referred to as 203K loans or Homestyle loans. The structure and purpose of these loans are the same; they are just backed by 2 different institutions. 203K loans are backed by the Federal Housing Administration, or FHA, and are generally intended for owner-occupants looking to renovate their property. These loans also typically only require a credit score of 580 to qualify. Homestyle loans, on the other hand, are backed by Fannie Mae and can be utilized by owner-occupants or investors with a higher credit score.

Renovation loans allow you to borrow based on your property’s post-ADU value, perfect for projects with high ROI potential.

Home Equity Conversion Mortgage (HECM, ages 62+)

HECM loans are a unique loan type available to homeowners age 62 or older. These loans are essentially a reverse mortgage. They allow a homeowner to convert part of their home’s equity into cash to pay for the upfront costs of construction, but repayment of these loans is deferred until the home is sold or the homeowner passes away.

So if you are a senior with significant equity in your home who is looking to add a guest house for a caretaker or adult children but wants to keep the monthly loan payments on your current loan the same, HECMs can be a great option.

HECM loans can enhance financial security for seniors by funding ADUs, providing rental income, and supporting long-term property planning.

ADU Finance Program

The loan products we have discussed so far are not unique to ADUs, though they can be used to cover the building costs for ADUs. The ADU finance program, on the other hand, is a type of loan created especially for this type of construction.

Especially in San Diego County, the government wants to incentivize ADU builds to increase affordable housing and combat the housing shortage. They created the ADU Finance Program to allow homeowners with moderate incomes the opportunity to build ADUs on their property. The loans provided through this program have appealingly low interest rates.

To qualify for this program, homeowners must live in the primary residence, make under $236,600 per year, and have a minimum credit score of 680. There is also an application fee due upon approval. To learn more about the program and find out if you qualify, you can go to the San Diego Housing Commission’s website.

Qualifying for the ADU Finance Program requires meeting residency, income, and credit criteria—key steps for securing affordable financing.

How to Compare ADU Financing Options

ADU financing looks different for every homeowner and every project. Some homeowners choose to finance the entire project with a single loan. Others use a combination of financing methods.

The best financing option for your construction depends on a variety of factors, including interest rates, loan terms, current property value, and the potential for rental income. While the chart below will help you compare pros and cons, you also need to speak to a certified financial advisor to see which loans you may be eligible for based on age, income, savings rate, and credit score. They may also provide options we have yet to mention here, like personal loans, for you to consider.

What is the Affordable ADU Bonus Program in San Diego?

The ADU Bonus Program is not a loan program, but it does encourage affordable housing construction by increasing the maximum number of ADUs that can be built on a property.

Currently, the state of California allows homeowners to have one ADU and one JADU, or Junior ADU, on their property in addition to the single-family home. The ADU can either be attached or detached but cannot exceed 1200 square feet.

However, if you intend to use your ADUs as affordable housing, you may qualify for the ADU Bonus Program and can build more ADUs on your property. To qualify for the ADU Bonus Program, homeowners must adhere to strict terms. For example, you must deed-restrict your ADUs as affordable housing for at least 15 years.

To learn more about eligibility requirements and how to apply, you can refer to this page on the San Diego County website.

Start Your ADU Project with Better Place Design & Build

In order to understand how to finance your ADU best, you need to first understand the potential costs, timeline, and overall construction process. When you schedule a consultation with Better Place Design & Build, we will not only sit down to discuss your ADU goals and potential floor plans, but we will also perform a free site assessment of your property to give you the most accurate estimate possible.

At Better Place, it’s our mission to take the complications out of ADU build, financial or otherwise, to create a stress-free build process from start to finish.