Construction Loans for ADU: Complete Guide for 2025

Accessory Dwelling Units (ADUs) have surged in popularity across the U.S. — from backyard cottages and garage apartments to basement suites. Homeowners are building ADUs to create rental income, house family members, or increase property value.

If you’re considering adding an ADU to your property, one of your first questions will be: How do I pay for it? For many, the answer is a construction loan for ADU projects. These loans are specifically designed to finance the cost of building or converting a space into a compliant, fully functional living unit.

In this guide, we’ll explain what ADU construction loans are, how they work, what lenders look for, and tips for securing the best financing for your project.

What Is an ADU?

An Accessory Dwelling Unit (ADU) is a secondary housing unit on a single-family lot. Common types include:

• Detached ADU: A stand-alone unit, such as a small house in the backyard.
• Attached ADU: Built as an addition to the main home.
• Garage Conversion: Transforms an existing garage into living space.
• Basement Apartment:Converts a basement into a separate dwelling.

ADUs must meet local zoning, building codes, and permitting requirements. In many areas, they are a key part of addressing housing shortages.

What Is a Construction Loan for ADU?

A construction loan for ADU is short-term financing that covers the costs of building or converting space into an ADU. Unlike a traditional mortgage, which pays a lump sum for an existing home, ADU construction loans:

• Release funds in draws tied to project milestones.
• Require interest-only payments during construction.
• Are typically replaced with a long-term mortgage, home equity loan, or other financing after completion.

These loans can finance:

• New detached structures
• Conversions of garages, basements, or attics
• Major remodels to create attached units

How ADU Construction Loans Work

1. Application & Approval
   • Provide project plans, permits, budget, and contractor details.
   • Lender reviews your credit, income, and property details.
2. Draw Schedule
   • Funds are disbursed in stages as work is completed (e.g., site prep, framing, electrical, finishing).
   • Inspections confirm completion before each draw.
3. Interest-Only Payments
   • You pay interest only on the funds drawn, not the total loan amount.
4. Conversion or Payoff
   • At project completion, the construction loan is either refinanced into a mortgage or paid off using long-term financing.

Types of ADU Construction Loans

1. Construction-to-Permanent Loan

• Combines construction financing and long-term mortgage into one.
• Single closing reduces costs and paperwork.
• Good for homeowners who want a streamlined process.

2. Stand-Alone Construction Loan

• Short-term financing for the build only.
• Requires separate permanent financing afterward.
• Offers flexibility to shop for long-term loan terms later.

3. Home Equity Line of Credit (HELOC)

• Uses existing home equity for ADU construction.
• Funds are drawn as needed; interest is paid only on what you use.
• Ideal for smaller ADU projects.

4. Renovation Loan

• Programs like the FHA 203(k) or Fannie Mae HomeStyle allow financing of improvements as part of your mortgage.
• Can be used for certain ADU projects if they meet program guidelines.

5. Local or State ADU Financing Programs

• Some municipalities offer low-interest loans or grants to encourage ADU development.
• Often come with specific eligibility requirements.

Benefits of an ADU Construction Loan

• Covers Full Build Costs – Land prep, materials, labor, permits, and inspections.
• Flexibility – Funds can be used for detached builds, conversions, or additions.
• Potential ROI – Rental income from the ADU can offset loan costs.
• Property Value Increase – ADUs can significantly boost resale value.

Considerations Before Applying

• Zoning & Permits: Confirm your property is eligible for an ADU under local regulations.
• Budget Accuracy: Cost overruns are common; include a contingency fund.
• Loan Timeline: Understand the maximum build time allowed by the lender (often 9–18 months).
• Exit Strategy: Have a plan for converting or paying off the loan after construction.

Lender Requirements for ADU Construction Loans

While criteria vary, most lenders require:

• Credit Score: Often 680+ for best terms.
• Down Payment: Typically 10%–20% of project cost for construction-to-perm loans.
• Licensed Contractor: Lenders prefer licensed, insured builders with ADU experience.
• Detailed Plans: Architectural drawings, permits, and itemized cost estimates.
• Loan-to-Cost (LTC) Ratio: Usually 70%–80%, meaning the lender covers that percentage of total cost.

How Interest Is Calculated

ADU construction loans typically have variable rates tied to an index like the prime rate, plus a margin. Interest is charged only on the portion of funds drawn.

Example:

• Loan amount: $150,000
• Month 1 draw: $30,000 → Interest on $30,000
• Month 4 draw: $90,000 total → Interest on $90,000

How to Find ADU Construction Loan Lenders

• Local Banks and Credit Unions – Often have knowledge of local ADU regulations and builder networks.
• Mortgage Brokers – Can shop multiple lenders for you, especially useful for complex ADU projects.
• Specialized Construction Lenders – Focus on renovation and ADU-specific financing.
• State & Local Programs – Check with your city or county housing department for ADU incentive programs.

Steps to Apply for an ADU Construction Loan

1. Confirm ADU Eligibility – Check zoning laws and secure necessary permits.
2. Select a Contractor – Choose one with proven ADU experience and good references.
3. Prepare Documentation – Financial statements, building plans, permits, cost breakdown.
4. Apply for the Loan – Submit all documents; lender evaluates your credit, income, and project.
5. Close on the Loan – Sign documents and start construction.
6. Manage Draws – Request funds as milestones are met; ensure timely inspections.
7. Project Completion – Transition the loan into permanent financing or pay it off.

Tips to Secure the Best ADU Construction Loan

• Improve Credit Before Applying – A higher score can lower your rate and down payment requirement.
• Get Multiple Quotes – Compare rates, terms, and fees.
• Work With a Lender Familiar With ADUs – Experience with local ADU rules can smooth the process.
• Include a Contingency Fund – Lenders like to see a cushion for unexpected costs.
• Know Your Timeline – Delays can impact financing terms.

Final Thoughts

Building an ADU can be a smart investment — whether for rental income, family housing, or property value. A construction loan for ADU projects gives you the funding to make it happen, covering costs from permits to finishing touches.

By understanding loan types, requirements, and the application process, you can choose financing that keeps your project on time and on budget. Work with a lender experienced in ADUs, prepare thorough plans, and manage your build carefully, and your new unit can be a valuable, income-producing addition to your property.