Financing Your Accessory Dwelling – Insights from 100+ Customers and a Few Bankers

Unsure about financing for your accessory dwelling project?

New Avenue has worked with over 100 clients and almost all of them finance their addition, remodel or accessory dwelling with traditional bank financing.   We interviewed both clients and loan officers at various banks to see what people do for financing.

Here are shared some insights into taking out a loan for a New Avenue project.

Q: Can traditional banks finance an accessory dwelling?

A: Yes, they can. This may be available through a HELOC, cash out refinance or a renovation loan. There are some guidelines to follow such as, the unit should not be more than 25% of the value of the home and should not exceed 30% of the square footage of the main home. These standards may vary by bank and there is some leeway if comps support the addition.

Q: How does an accessory dwelling differ from a Second Unit?

A: Adding a second unit or accessory dwelling may make your home a Multi-Unit property in the eyes of a bank.   None of our clients have ever done this. Instead, people typically use a the HELOC, cash our refi or conventional renovation loan.

Q: Can you get Renovation Loans?

A: Many banks offer a nice variety of renovation loans however a cash out refinance is often the best way to go.  Remodel loans often require the unit to be attached to the current home and is limited to Conventional Loan Limits, $800,775 loan amount in most Bay Area Counties.  Wells Fargo has provided these loans for our clients in the past.   For renovation loans, customers can do the FHA 203K, the FNMA Homestyle or what banks calls “portfolio” loans.  Portfolio loans are loans that the bank actually makes with their own assets.  “Traditional” loans are backed by Fannie Mae so they are not held by the bank.  A good banker will look at which works best for you.

Q: What is the best way to borrow $100-200,000 for a remodel, addition or accessory dwelling?

A:  A loan officer at any bank should gather the information on your current home loan, current home value and the cost of the project. They can then compare whether a Cash Out Refinance, a Home Equity Line of Credit (HELOC), or a renovation loan makes the most sense. If the homeowner has enough equity, the Cash Out Refinance or HELOC typically make the most sense and they are the easiest way to finance the project. Almost ALL CLIENTS use either a cash out refinance or a HELOC.

Q: What are the types of loans and which ones have the lowest cost?

A: These are the types of loans we’ve seen in order of frequency:

1) Cash Out Refinance

2) Home Equity Line of Credit

3) Renovation Loans.

The costs for the HELOC are the lowest to obtain the financing. But they tend to be Adjustable Rates and have higher interest rates than just refinancing. The Cash Out Refinance and the Renovation loans are fairly similar in rates, but the Renovation loans would have more closing costs associated with it.

Don’t underestimate the idea of using family or friends who can either lend directly to you or they can borrow against their own home.  This is fairly common for remodel or new construction projects. It’s often better to keep that interest in the family than pay it to a bank.

Q: What type of income do you need?

A: Most every loan today is looking at keeping your “Debt to Income” ratios under 43% of your gross income. This includes housing payments, installment loans and revolving accounts. Banks don’t include utilities, cell phone, cable, etc… Banks can consider higher if the client has compensating factors, such as a lot of cash reserves, job stability and ability to handle the housing payments.

Q: What if I have lots of equity but little income?

A: Banks make loans base on the client’s ability to repay them. Equity is great, but banks need to make sure that you will not be overburdened by the additional payments. They do this by looking at your W-2.  Self employed or business owners, or partnerships may really struggle to meet these income requirements.  That is why banks limit payments to 43% of their gross income.

Q: What if I have a good job but little equity in my home?

A: The great thing about renovation loans is that they are based on the “after completed value”. Most additions to the home will add value and so you are able to make the improvements if it fits your income level.

We can put you in touch one of the loan officers who has worked with clients in the past to answer your financing questions and chat about your project.

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