- Backyard tiny homes, called ADUs, are becoming increasingly popular.
- Despite the interest, it can be hard to finance one.
Backyard tiny homes, called accessory dwelling units or ADUs, are becoming more popular as some state and local governments roll back zoning restrictions.
But financing ADUs is still a struggle as mortgage guidelines have not caught up.
That's because government-backed mortgage providers Fannie Mae and Freddie Mac set the strict standard for all other mortgage lenders.
"Until Fannie and Freddie says 'We can take a property with an ADU on it,' then a lot of lenders are going to be scared of doing that, scared of repackaging that loan for Fannie or Freddie in the future," said Ryan O'Connell, founder of How To ADU, an ADU advocacy organization in California.
Even with these restrictions, there are ways to pay, he said.
Check zoning laws to see if ADUs are allowed in your area, and if they are, here are some avenues that could help finance one.
Pay in cash
If you're lucky enough to have between $100,000 and $400,000 in cash lying around — the range in cost for a typical ADU — then you can potentially finance your ADU without taking out loans.
It will get it done faster, increasing your property value while allowing you flexibility on how to use it (rental property, home for adult children, downsizing).
If you rent it, the income will go directly into your pocket — no loan payments necessary — and will eventually make up for the cash that you've put in at the beginning.
The prospect of using savings can be daunting. Even on the low end, that's more than the cost of a 20% down payment on the average home in the US, which was $420,000 in August, according to Redfin.
Research public grants and forgivable loans
As the housing shortage becomes more dire, states and local governments are trying to come up with ways to spur housing development — quickly and affordably.
Three states — New York, California, and Vermont — fund ADU development or improvement through grant programs.
But read the fine print carefully.
Only certain people qualify, and in some cases the funds must go toward specific parts of the project, making it likely you'll have to find additional financing for your ADU. Also, some people that have received the grant told Insider that the process can be arduous.
Some cities, counties, and local nonprofits are providing funding to help homeowners build ADUs.
For example, a neighborhood in Denver, Colorado, has a nonprofit that is helping homeowners with ADU costs, the Denver Post reported.
In Napa County, California, residents can receive a forgivable loan for a portion of the project if they commit to renting the unit out at an affordable rate designated by the county for five years.
Take out a home equity line of credit — if you can
Because ADUs are a relatively new concept, it can be tricky to get a bank to fund one.
It's getting easier, though. Fannie and Freddie have been pulling back its restrictions on funding ADU projects, O'Connell said.
Some local banks are coming up with creative ways to help homeowners finance this, he added. For example, his local bank — Redwood Credit Union, in California — sets aside funding specifically for loans for ADUs.
The interest rate is around 4%, O'Connell said. That's much lower than the typical mortgage rate. Additionally, you can complete the whole project without paying interest, he said, through their deferred payment program.
Sometimes, when financing an ADU loan, programs like RCUs may consider the property's worth after the ADU is constructed when underwriting the loan. It allows homeowners to access more funding than they would be able to otherwise.
The drawback to this method is that there is a patchwork of policy — these local bank programs vary widely, if they exist. Still, it's worth investigating whether your local bank or credit union has a program that works.
There are several third-party providers that partner with local banks to offer some ADU financing.
The finance technology company RenoFi is an example of this. They operate nationally, but in California, specifically, "they have engineered partnerships with credit unions" to essentially finance the same type of loan that a credit union like RCU has, O'Connell said. RenoFi gives you up to 90% of the future value of your home.
Take out a private loan
Some can take out private loans to fund their ADUs. This has gotten trickier to do, though, with high interest rates.
O'Connell said that more people are borrowing against their retirement, including taking a loan out of their 401(k) accounts. While some may see that as a faster route, it's crucial to note: Insider's personal finance desk does not recommend drawing a loan out of your 401(k) unless it's a last resort, including paying off high-interest debt, or in an emergency situation. Neither of these situations include building an ADU.
Team up with family and friends to invest together
You can also team up with a parent, child, sibling, or friend to get an ADU built. Two bank accounts are better than one.
A mother-daughter duo in the Bay Area told Insider about their experience doing this last year. Mother Barbara Clark and her husband were planning for retirement, and realized they could not pay their high mortgage on a fixed income. Meanwhile her daughter, Katie Sandoval-Clark, could not afford to live near her parents with her current income.
So, Clark and her husband paid for the down payment on a new home, and for the ADU with the funds that they got selling their old home. Sandoval-Clark and her husband will pay the mortgage each month. Clark and her husband moved into the main home, and Sandoval-Clark and her family live in the ADU.
Now, Sandoval-Clark gets to raise her children near her grandparents, and eventually, the two families will swap as the two children get older.
This kills two birds with one stone — and, as O'Connell noted, comes with the added perk of a free babysitter for the coming decades.