Best type of loan to build an ADU
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Dan H.Pro Member
Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votesQuote from @Alan Asriants:
Likely a home equity loan might be better since you dont have to worry about paying off the equity quickly and arent subject to higher rates and random rate changes which can destroy your cash flow.
Long term loans are best for long term projects
HELOC and lines of credit are good for get in and get out situations.
Its possible you can use a heloc to build the property as that can be cheaper for you and then you can do a cash out refi to pay off the heloc since your home is fully paid off. That might be cheaper and better bet than home equity loan. YOu need to reach out to local bank and see difference in rate and terms.
Also you need to know that investing 100k in an adu will not always increase your value by 100k. (Example)
if you need a solid contractor in the area for a bid, reach out anytime. my partner is a solid builder
>you need to know that investing 100k in an adu will not always increase your value by 100k. (Example)
I would word this much stronger. It is rare for a single ADU addition in southern CA to add as much value as the hands cost of adding the ADU. This creates a negative position that needs to be recovered before sny cash flow is achieved. Search Bigger Pockets for posts on ADU valuation. Make sure before you add an ADU you know the value that will be added.
Here are reasons adding a single ADU to a single family home in Southern CA is typically a poor investment.
1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.
Do accurate and conservative underwriting to include the likely initial negative position. I have literally seen underwriting that depicts over a decade to recover the initial negative position.
Good luck
9 Replies
- 1yAlan AsriantsBusiness MemberReal Estate Agent · Philadelphia, PA · Member since 2019 · 1k+ posts · 1k+ votes
Likely a home equity loan might be better since you dont have to worry about paying off the equity quickly and arent subject to higher rates and random rate changes which can destroy your cash flow.
Long term loans are best for long term projects
HELOC and lines of credit are good for get in and get out situations.
Its possible you can use a heloc to build the property as that can be cheaper for you and then you can do a cash out refi to pay off the heloc since your home is fully paid off. That might be cheaper and better bet than home equity loan. YOu need to reach out to local bank and see difference in rate and terms.
Also you need to know that investing 100k in an adu will not always increase your value by 100k. (Example)
if you need a solid contractor in the area for a bid, reach out anytime. my partner is a solid builder
Alan Asriants - New Century Real Estate 590 Reviews- 1yDan H.Pro MemberInvestor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
Quote from @Alan Asriants:
Likely a home equity loan might be better since you dont have to worry about paying off the equity quickly and arent subject to higher rates and random rate changes which can destroy your cash flow.
Long term loans are best for long term projects
HELOC and lines of credit are good for get in and get out situations.
Its possible you can use a heloc to build the property as that can be cheaper for you and then you can do a cash out refi to pay off the heloc since your home is fully paid off. That might be cheaper and better bet than home equity loan. YOu need to reach out to local bank and see difference in rate and terms.
Also you need to know that investing 100k in an adu will not always increase your value by 100k. (Example)
if you need a solid contractor in the area for a bid, reach out anytime. my partner is a solid builder
>you need to know that investing 100k in an adu will not always increase your value by 100k. (Example)
I would word this much stronger. It is rare for a single ADU addition in southern CA to add as much value as the hands cost of adding the ADU. This creates a negative position that needs to be recovered before sny cash flow is achieved. Search Bigger Pockets for posts on ADU valuation. Make sure before you add an ADU you know the value that will be added.
Here are reasons adding a single ADU to a single family home in Southern CA is typically a poor investment.
1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.
Do accurate and conservative underwriting to include the likely initial negative position. I have literally seen underwriting that depicts over a decade to recover the initial negative position.
Good luck
- Lender · Nashville, TN · Member since 2024 · 700 posts · 284 votes1y
Hey Tony,
I believe we've spoken in the past regarding this exact same project.
To get the least costly option I recommend getting a DSCR cash out refinance done on the property for the funds needed. If your intention is to pay it off, you can opt for a short prepayment term.
HELOC's have higher interest rates, income documentation requirements and limit your potential for securing more debt in the future as it reports on your personal credit.
- 1yMatthew BernalBusiness MemberInvestor · Austin, TX · Member since 2021 · 497 posts · 126 votes
🔹 Best Loan Options for Building an ADU in Garden Grove, CA 🔹
Great question! Since you own the property free and clear, you have several financing options to consider. Each has different advantages depending on your tax strategy, cash flow goals, and risk tolerance.
🏡 1. Home Equity Loan (HEL) – Best for Fixed Rates & Predictability
A Home Equity Loan (HEL) lets you borrow a lump sum against your home’s equity at a fixed interest rate. This is a solid option if:
✅ You want predictable monthly payments
✅ You’re looking for a one-time financing option for ADU construction
✅ You prefer a longer repayment period (10-30 years)
🔹 Potential Tax Benefit: Interest may be deductible if the loan is used for substantial improvements to the property. Consult your CPA to confirm.
💳 2. Home Equity Line of Credit (HELOC) – Best for Flexibility
A HELOC gives you a revolving line of credit based on your home’s equity. Think of it as a credit card secured by your property with a variable interest rate. Great if:
✅ You want flexibility and only borrow what you need
✅ You plan to do construction in phases
✅ You want interest-only payments during the draw period
⚠️ Risks: Since HELOCs have variable interest rates, your payment can increase if rates rise.
🔹 Tax Benefit? Similar to a HEL, interest is potentially deductible if funds are used for home improvements.
🏗️ 3. Cash-Out Refinance – Best for Low Interest Rates
With a cash-out refinance, you replace your existing mortgage (which you don’t have) with a new loan for a higher amount, pocketing the difference. This works well if:
✅ You want one mortgage payment instead of multiple loans
✅ You can lock in a low, fixed rate
✅ You plan to invest in additional renovations beyond the ADU
⚠️ Downside? You’ll start a new mortgage with closing costs, so it’s not always the best option unless you’re borrowing a large amount.
🏦 4. Construction Loan – Best for Larger Projects
If you’re building a high-end ADU, a construction loan may be a good option. These are typically short-term, interest-only loans that convert to a traditional mortgage upon project completion. Best if:
✅ You want funds disbursed in stages to control costs
✅ You plan to significantly increase property value
⚠️ Downside? These loans can have higher rates and require more paperwork.
📌 Final Thoughts: What’s the Best Option?
If you need a lump sum with a fixed rate → Home Equity Loan ✅
If you want flexibility to borrow as needed → HELOC ✅
If you want to refinance and access equity at a low rate → Cash-Out Refi ✅
If you plan a large-scale project → Construction Loan ✅
💡 Pro Tip: Talk to your lender and a CPA to ensure you’re maximizing tax benefits and choosing the best loan structure for your long-term goals. If you’re planning to rent the ADU, a HELOC or cash-out refi could be great options since interest may be deductible as a rental expense.
Would love to hear what others in the community have done for their ADU financing! 🚀
- Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes1y
The ADU would be on the same parcel as the main house. So to do those repairs/upgrades, I would probably just refinance the house (assuming you have the equity). I see HELOCs as more useful for buying a different property for "cash" and then once the rehab is done, refinancing it and paying off the HELOC. Since these are permanent upgrades, I think a normal refinance would be best. I don't think there would be any tax advantages either way.
- 1yErik EstradaBusiness MemberLender · Member since 2022 · 6k+ posts · 1k+ votes
Quote from @Tony Dinh:
I have an investment property that is fully paid off in garden grove California. I plan on doing some renovations to the main house and building an ADU.
I wanted to see what would be the best type of loan that I should be looking into. In terms of potential tax write offs and savings? HEL, HELOC?
From a cost standpoint, HELOC is the way to go. Some lenders may require that you draw a certain amount at closing, however if you get a HELOC at a local bank and credit union, you should be able to avoid this. The benefit to a HELOC is that you get to draw what you need and only pay interest on what you draw. The goal with this is to pay it off quickly, as the rate is only fixed for a short period of time.
LuxePrivate Investments LLC 572 Reviews - 1yAshish AcharyaBusiness MemberCPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
@Tony Dinh Since your property is paid off, a HELOC offers flexibility but has variable rates, while a Home Equity Loan (HEL) has fixed rates—both are tax-deductible if used for ADU construction. A cash-out refinance may provide lower rates and longer terms, while a construction loan is tailored for major projects. If the ADU is rented, costs are depreciable, and mortgage interest remains deductible. Check California ADU grants for possible savings, and consult a real estate CPA to optimize tax benefits.
This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.
INVESTOR FRIENDLY CPA®5241 Reviews - 1yKo KashiwagiPro MemberLender · Los Angeles, CA · Member since 2022 · 967 posts · 445 votes
HELOC or HELOAN would be great if you can find the right program and qualify. Typically, underwriting will be based off of personal income so you'd need to meet the DTI requirements and show ability to repay - which you can qualify with either tax returns or bank statement. I recently did this for a Sacramento property.
Otherwise you could do a simple cash out bridge loan and get typically up to 75% of current value and sometimes more and benefit is these are business purpose loan so you can have the property vested under LLC and it won't ask for income metrics
- 1yStephanie MedellinBusiness MemberMortgage Broker · CA · Member since 2014 · 1k+ posts · 642 votes
A traditional cash out refinance would work here, and would probably be the most cost-effective loan option available, with a fixed rate that will (in most cases) be lower than a HELOC. The benefit with the HELOC is that you're only paying interest on the portion of the funds used, but these will likely carry higher rates on an investment property.
Since you already have a paid off home with equity available, I would not recommend a renovation loan unless the main home is in such disrepair that it can't qualify for a mortgage (i.e. roof leaks or major damage). Even though renovation loans can take into account the "after repair value" of the home, you likely don't need the additional value to qualify. You can also avoid the additional oversight of your project by the lender and you'll have more flexibility if you need to make changes throughout your project.
While I can't speak to tax strategies, you should be able to list the mortgage interest for investment properties on your schedule E, whether it's a HELOC or an equity loan / cash out refinance.
Stephanie Medellin, Loan Factory58 Reviews
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