An accessory dwelling unit (ADU) can serve several functions. It can be an apartment for an in-law, a room for a child to sleep in during college breaks, a guest bedroom or an apartment to rent out to generate extra income. Converting your garage to an accessory dwelling unit can also significantly increase your home’s value.
A renovation of that scale can cost hundreds of thousands of dollars. If you have owned your house for several years and have built up a substantial amount of equity, you may want to tap into it to finance the project. There are a few ways to do that.
Home Equity Loan
If you take out a home equity loan, or a second mortgage, you’ll be able to borrow a lump sum and pay it back over time. Since you’ll be taking out another mortgage, you’ll have to go through an appraisal and pay closing costs, which can add up to thousands of dollars. Your interest rate for a home equity loan will also be higher than the rate on your original mortgage.
Home Equity Line of Credit
Another option is to request a home equity line of credit (HELOC). That will give you a revolving line of credit that you can use as you need it. You will only have to pay interest on the amount of available credit you use. The interest rate on a HELOC will most likely be variable. That means your monthly payments may go up and down as the interest rate changes, similar to the way they do with a credit card.
Cash-Out Refinance
With a cash-out refinance, you’ll be able to access a portion of the home equity you’ve built up over the years to pay for the construction of an accessory dwelling unit. The amount of equity you use will be added to your loan balance. You will also have to pay closing costs. A cash-out refinance may be a good option if you can qualify for a lower interest rate than you have on your current mortgage.
Which Financing Option Is Right for You?
Every homeowner’s situation is different. With each of these options, you will only be able to access a percentage of the equity you have built up. That may or may not be enough to cover the cost to convert your garage to an accessory dwelling unit. If you choose a home equity loan or a cash-out refinance, compare rates from several lenders and consider closing costs.
When you communicate with a lender, explain the purpose of the accessory dwelling unit you’re thinking about building. If you’re planning the project to raise your home’s value, generate rental income or have a family member move in to reduce overall expenses, that information can influence a lender’s decision.
