property types

Accessory Dwelling Units – Financing and Rental Income Allowances

Accessory Dwelling Units or ADU’s sometimes known as Granny Flats, Guest house, Back House, or it might be an office. They must contain a fully functioning kitchen and bathroom. These can be attached, inside or detached from a primary dwelling. Since they can’t have a separate lien on them per se’ as they are part of the main home property, if you want to add one to your property you will need to get creative with financing. If you have a strong equity in your property, you could consider a cash out refinance, or a 2nd mortgage or Home Equity Line of Credit to construct one. It’s also possible to take out a construction loan as you might with a home remodel that replaces the first mortgage and then doles out regular draws to your builder for the construction of your ADU and any other improvements you are wishing to make.

Sometimes income from an ADU can be used to qualify for a conventional mortgage loan

Using income and proposed income from an ADU is tricky as not all agencies and investors allow it to be included. There are some exceptions. The first is that if a caregiver for someone in the household lives in the ADU and pays rent, then the income can be used. Fannie Mae has a program for first time homebuyers called HomeReady where a borrower must meet the income parameters for properties being purchased in designated census tract. Within those, rental income from an ADU is acceptable so long as the main dwelling isn’t more than one unit.

Freddie Mac, however, changed their guidelines for purchase and “no cash-out” refinances at the end of 2022 to allow income from legal ADU rental income of up to 75% of the gross monthly rent, so long as the total doesn’t exceed 30% of the total stable monthly income being used to qualify the borrower for the mortgage.

FHA has provision for Accessory Dwelling Units (ADU)

FHA allows ADU’s but they can’t be a manufactured home and if the primary dwelling is a manufactured home then an ADU is not allowed. Some lenders may allow rental income from an ADU on an FHA purchase with an Operating Income form done by a property appraiser. If there is a current rental agreement on it, then they will use 75% of the lesser of the actual rent as evidenced by a rental agreement or what the appraiser reports as fair market rent. VA may be the same case in that under certain circumstances boarder and rental income are allowed for the purpose of offsetting the new mortgage payment. This may be subject to an underwriter’s overall review of the file and expected success for rental as well as borrower capability and rental history. Check with your mortgage broker for specifics on this situation for details that would be specific to the situation.

When an existing ADU is illegal in the zoning but common in the area, conventional financing may still work

Sometimes you come across a property you love and it has an ADU on it that is technically not allowed under the local zoning – like an ADU isn’t allowed under any circumstance. Fannie Mae says that the property is still eligible for financing if:

  • The ADU’s existence doesn’t keep it from a future property insurance claim if it were filed on the property
  • The ADU conforms to the local neighborhood and market
  • The current property use is what the appraiser uses in the appraisal
  • The noncompliance with the current zoning is noted by the appraiser in the appraisal report
  • Appraiser con demonstrate in the appraisal that the improvements are typical for the market with at least two comps with the same non-compliant zoning use from settled sales.

Tiny Home as an ADU might work if it’s on a foundation and permitted properly with the local jurisdictions. Note that some lenders may have a requirement of the living space be at least 400 square feet.

ADU’s can be a great way to house a family member, have an office, or just supplement your income. If you have questions on how a lender might view a particular scenario, contact a professional mortgage broker in your area. If you are in a West Coast state, please tap the yellow floating icon below and reach out. Always happy to help!

Kristin M Eklund NMLS #1872091
Latest posts by Kristin M Eklund NMLS #1872091 (see all)