HELOCs for Accessory Dwelling Units (ADUs)

An accessory dwelling unit (ADU) is a smaller, secondary living space on the same property as a single-family home. Think of it like a mini apartment or a guest house. It has its own entrance, kitchen, bathroom, and living area, but it’s not a completely separate property. 

People often use ADUs for family members, guests, or even as a rental unit for extra income. ADUs can be part of your main house, like a converted garage or basement, or separate structures in your yard, like a tiny house or a cottage.

Lender	Rates (APR)	Loan amounts
Figure	7.85% – 17.20% fixed	$15,000 – $400,000
Bethpage FCU	8.50% – 18.00% variable (6.99% fixed intro rate for 12 months)	$10,000 – $1 million

Best HELOCs for ADUs

Building a typical ADU can cost anywhere from $60,000 to $225,000, depending on materials, labor, and design. A home equity line of credit (HELOC) is one of many ways to finance the project. 

HELOCs let you borrow against the equity you’ve built up in your home—often at a lower interest rate than other financing options. Plus, your interest may be tax-deductible since it’s for home improvements.

We analyzed dozens of nationally available HELOC lenders and found that Figure, Bethpage Federal Credit Union, and Hitch provide the best HELOCs for ADUs: 

Figure

Bethpage Federal Credit Union

Why use a HELOC for an accessory dwelling unit?

If you already have equity built up in your home, using it to fund an ADU project is definitely worth considering. Here’s why: with a HELOC, you can tap into your funds whenever you need them. That’s a huge plus if you’re unsure how much your ADU will cost or if you want to tackle the project bit by bit.

Another big perk of using a HELOC for your ADU? You could save some serious cash. HELOC rates are usually lower than what you’d get with a personal loan or credit card, so you’ll save money over the life of your loan. 

And, if you itemize your taxes, you might even be able to write off your HELOC interest, according to the Internal Revenue Service (IRS).

Lastly, some lenders might offer special deals or discounts if you use your HELOC for home improvements like an ADU. These discounts could include special introductory rates or extended repayment periods, so it never hurts to ask.

Ask the expert

Catherine Valega

CFP®

HELOCs are a great option for funding ADUs. However, I always caution my clients to fully understand the impact of that extra loan payment (in addition to their mortgage payment). I like my clients to afford these payments on one salary, in case one partner loses their job. 

Pros and cons of building an ADU with a HELOC

Pros

• Increased property value

  Adding an ADU to your property can boost its value and give you a nice return on your investment.

• Extra income

  You could bring in extra monthly cash if you rent out your ADU.

• Flexible living arrangements

  An ADU is perfect for giving family members their own space or housing guests without sacrificing privacy.

• Lower interest rates

  HELOCs usually have lower interest rates than other financing options like personal loans.

• Potential tax deductions

  You might be able to deduct your HELOC interest on your taxes since you’re using it for home improvements but talk to a tax professional first.

Cons

• Variable interest rates

  HELOC payments are hard to predict because most have variable rates that can change over time.

• Will increase your debt load

  Building an ADU isn’t always cheap. You’ll need to factor in construction costs, permits, and other expenses, and ensure you can comfortably pay those costs back over time.

• Foreclosure risk

  You could risk losing your home if you can’t make your HELOC payments.

• Potential zoning restrictions

  Some cities have strict zoning laws limiting or prohibiting ADUs, so do your homework before starting your project.

How to qualify for a HELOC

If you’re considering using a HELOC for an ADU, the first step is ensuring you qualify. Lenders will look at a few key factors:

• Equity. You’ll need a decent chunk of equity in your home, usually at least 15% to 20%. 
• Credit score. Most lenders want to see a credit score of 620 or higher. 
• Debt-to-income ratio. Aim for a DTI ratio of 43% or less, meaning your monthly debt payments don’t consume too much of your income. 
• Loan-to-value ratio. Your LTV ratio (the amount you’re borrowing compared to your home’s value) should be 80% or less.

If you meet these requirements, you’re in good shape to start shopping for a HELOC for ADUs. Here’s what to do next:

1. Get prequalified. Many lenders offer online prequalification tools that give you a ballpark idea of how much you can borrow without affecting your credit score.
2. Compare lenders. Don’t just go with the first lender you find. Grab offers from at least three lenders to find the best loan for your project.
3. Gather your documents. When you’re ready to apply, you’ll need proof of income (like pay stubs or tax returns), bank statements, and information about your debts and assets.
4. Submit your application. Once you’ve chosen a lender, complete the application and provide any requested documents.
5. Wait for approval. The lender will review your application and let you know if you’re approved. They may also order a home appraisal, which can take a few days to a few weeks.
6. Close on your HELOC. If approved, you’ll need to sign the final paperwork and pay any closing costs (which can often be rolled into your loan).

And that’s it! With your HELOC funds available, you can start building your dream ADU. Remember to borrow responsibly and have a solid plan to repay your loan.

Ask the expert

Catherine Valega

CFP®

I recommend fully investigating the feasibility and zoning restrictions for an ADU before considering how you’ll finance the project—they are not approved for use in all locations.

Alternatives to HELOCs for ADU financing

When considering financing options for an ADU, a HELOC is just one avenue to explore. Several alternative financial products might better suit your needs, depending on your specific situation. Here’s how a cash-out refinance, a personal loan, and a construction loan stack up against a HELOC for ADU financing.

Home equity loan

A home equity loan is a prominent alternative to a HELOC for ADU financing. It provides a lump sum based on your home’s equity. Unlike a HELOC’s revolving credit line, a home equity loan has fixed monthly payments and a set repayment period. This can simplify budgeting but lacks a HELOC’s flexibility, allowing you to borrow as needed. 

The fixed interest rate of a home equity loan provides predictability, but you might miss out on the potential cost savings if interest rates drop, as can occur with variable-rate HELOCs.

Cash-out refinance

A cash-out refinance allows you to refinance your current mortgage for more than you owe and take the difference in cash. It’s a reasonable alternative if you have significant equity in your home. This option can provide a lump sum of money at potentially lower interest rates than other types of loans.

Unlike a HELOC, which acts as a revolving line of credit, a cash-out refinance replaces your mortgage with a new one. This means you start fresh with your mortgage term, often extending the repayment period. You may secure lower interest rates and consolidate your debt into one loan with a single monthly payment.

However, extending your mortgage term can result in paying more interest over time. Closing costs for a refinance can be substantial, adding to your expenses upfront.

Personal loan

A personal loan can provide quick funding without tapping into your home’s equity. These unsecured loans mean you don’t use your home as collateral, making the approval process faster and less stringent. 

The trade-offs include higher interest rates and shorter repayment terms compared to HELOCs. Personal loans are ideal if you don’t have substantial equity in your home or prefer not to attach a lien. However, the monthly payments can be more burdensome due to the higher interest rates.

Construction loan

A construction loan caters to building projects, offering funds in stages as the work progresses. This product provides the necessary capital but requires detailed plans and regular inspections. 

A construction loan is shorter-term and converts to a traditional mortgage upon project completion. This type of loan often has higher initial interest rates but can transition to more favorable terms. However, construction loans demand more oversight and documentation, which can be cumbersome compared to the simplicity and flexibility of tapping into a HELOC.

FAQ

How does a HELOC work?

A HELOC is a line of credit that allows you to borrow against your home equity. HELOCs have a draw period, during which you can use your credit line, followed by a repayment period. 

Draw periods can last five to 10 years, while repayment periods can last up to 20 years. You may be required or given the option to make interest-only payments during the draw period. You only pay interest on the amount of your credit line you use.

How do I know if I got a good HELOC rate?

The simplest way to evaluate whether a HELOC rate is “good” is to compare it to HELOC rates from other lenders. 

However, it’s essential to remember that what constitutes a good rate for you may differ from someone else. Your credit scores and income can influence the rates you pay. The best HELOC rate is the lowest one you can be approved for based on your credit and other qualifications, considering what fits in your budget.

Do interest-rate hikes affect my HELOC rate?

Interest-rate hikes can affect your HELOC rate if you have a variable-rate loan. Variable-rate HELOCs are tied to an index rate; when that index rate goes up, the rate on your HELOC can also increase. HELOCs are indexed to the prime rate, which follows movements in the federal funds rate. 

The federal funds rate is the rate at which banks lend to one another overnight. When the Federal Reserve adjusts the federal funds rate up or down to steer economic policy, HELOC rates can follow suit. 

How we chose the best HELOCs for ADUs

Since 2018, LendEDU has evaluated home equity companies to help readers find the best home equity loans and HELOCs. Our latest analysis reviewed 850 data points from 34 lenders and financial institutions, with 25 data points collected from each. This information is gathered from company websites, online applications, public disclosures, customer reviews, and direct communication with company representatives.

These star ratings help us determine which companies are best for different situations. We don’t believe two companies can be the best for the same purpose, so we only show each best-for designation once.

Recap of the best HELOCs for ADUs

Lender	Rates (APR)
Figure	7.85% – 17.20% fixed
Bethpage FCU	8.50% – 18.00% variable (6.99% fixed intro rate for 12 months)