How Do You Finance an ADU? HELOC vs Construction Loan Compared
Figuring out how to pay for an ADU is one of the most stressful parts of the entire process. You know you want to build an ADU, you're excited about it, and you have a plan or vision of how it's going to help you and your family, but you keep getting stuck when it comes to paying for the whole thing.
We get it. At BuildX, we have helped so many Massachusetts families navigate this whole process. Since we are a custom home builder who specializes in building ADUs all over this state, we are a big part of the financing conversations for almost every project we take on. Some people have a very clear plan when they call us, but most people have tons of questions about their financing options. They need help navigating the differences and pros and cons of options like HELOC, or a construction loan, or something else entirely. It depends on what makes the most sense for their situation and their ideas on their future ADU.
As with most things, there is no universal right answer that works for every situation or family. The best financing option depends on the equity you have in your current home, what your timeline is, and what you plan to utilize your ADU for after it's finished. What we can do is walk you through exactly how each option works, what they cost, and help you figure out what your best option is.
Quick Answer: For most people in Massachusetts who plan to build an ADU, the best way to finance the build usually ends up being a home equity line of credit (HELOC) because it is the least expensive and most flexible option. HELOCs have low closing costs, sometimes less than $2,000, they require only interest payments during construction, and they carry no penalties for early pay-off. Construction loans are another good option, but they work better when you don't have a lot of equity in your home or if you plan to keep the ADU as a long-term rental without selling another home. The choice depends on your existing equity, timeline, and intentions for your project.
In This Article
- What Are Your Main Options for Financing an ADU?
- How Does a HELOC Work for ADU Construction?
- How Does a Construction Loan Work for an ADU?
- What About FHA 203k Loans for ADU Construction?
- How Do These Options Compare Side by Side?
- When Is a Construction Loan Better Than a HELOC?
- Which Financing Option Is Right for Your Situation?
- Ready to Talk Through Your Financing Options?
What Are Your Main Options for Financing an ADU?
Let's go into a little more detail. When financing an ADU in Massachusetts, most homeowners choose between these three options: a home equity line of credit (HELOC), a construction loan, or an FHA 203k renovation loan. Each one has different benefits, costs, and requirements.
As we kind of already touched on, we see the majority of our clients use a HELOC because of its flexibility and the fact that the upfront costs are lower. However, the right choice depends on what your financial situation is and what you plan to do after the ADU is complete.
How Does a HELOC Work for ADU Construction?
A home equity line of credit allows you to borrow money using the equity in your existing home as collateral. Unlike a traditional mortgage where you receive the whole amount of the loan upfront and start making full principal and interest payments right away, a HELOC functions more like a credit card secured by your property.
How Do HELOC Payments Work During Construction?
Here's the great thing about this option. You only pay interest on the money you have actually drawn or used on the project thus far. So if you have a $400,000 HELOC but have only used $50,000 so far, you only pay interest on the $50,000, which can save you a lot of money over time. As your contractor draws more funds and the project continues, your monthly payment increases little by little. Because we build ADUs in roughly 100 to 110 days, your total interest expense during construction stays lower compared to longer projects.
What Are the Closing Costs for a HELOC?
HELOC closing costs are significantly lower than a regular mortgage or construction loan. Most HELOC programs cost between $700 and $2,000 in closing costs when it's all said and done. Compared to a standard mortgage, which typically runs $12,000 to $15,000 when you add up all the closing costs and prepaid items.
Can You Pay Off a HELOC Early?
That's the great thing, yes you can! HELOCs almost never have prepayment penalties. This makes them great options for homeowners who plan to sell another property after the ADU project is complete. You can pay off the entire balance the day after your home sale closes and just be done with it. Another neat thing you might not know is, the line of credit remains open, usually for up to 10 years, so you could use it again later if needed without going through the whole process again.
How Much Can You Borrow With a HELOC?
Lenders will often allow you to borrow up to 85% of your home's value through a HELOC. For example, if your home appraises at $600,000 and you have no existing mortgage, you could potentially get a loan of up to $510,000. Keep in mind that HELOC renovation loans usually max out between $500,000 and $750,000 depending on the bank and your situation.
How Long Does It Take to Close a HELOC?
Here's another good thing about going this route. HELOCs close faster than construction loans because they go through a different division than the mortgage division. They go through the consumer lending department. You can expect a quick three to four weeks from application to closing. After closing, Massachusetts law says that there must be a three-day "right to rescind" period before you can actually access the funds, so realistically plan on the process taking about a month.
How Does a Construction Loan Work for an ADU?
Construction loans are similar to a traditional mortgage, but they are designed specifically for building projects such as ADUs. The lender provides funds in draws as construction progresses, similar to a HELOC. The main differences are in how the loan is structured and the costs of the loan.
How Do Construction Loan Payments Work?
Unlike a HELOC where you pay interest only on the money you have used, construction loans often require principal and interest payments from day one. To put it simply, this means higher monthly payments during construction, even though your ADU is not finished or potentially generating any income yet.
What Are the Closing Costs for a Construction Loan?
When it comes to a construction loan, the costs are very similar to standard mortgage costs, usually between $12,000 and $15,000 including closing and prepaids. You may also need to pay points depending on your credit profile and market conditions.
What Additional Requirements Come With Construction Loans?
Construction loans usually require inspectors from the bank to verify the progress of the project before releasing new money for the next phase. This can sometimes create delays if inspectors are busy and aren't able to schedule inspections on your timeline. Lenders also conduct full appraisals, not just the automated values that are commonly used for HELOCs.
What About FHA 203k Loans for ADU Construction?
The last of the 3 options is FHA 203k loans. These are government-backed renovation loans that allow you to finance up to 110% of your home's projected future value after the ADU is complete. This is a riskier option, but can be more attractive for homeowners who have limited equity or believe the ADU will significantly increase their property value.
The catch is that 203k loans roll everything into a standard mortgage at current market rates. The reason you may not want that is if you currently have a low rate on your mortgage, you would lose that low rate when you refinance everything into the 203k. The loans also come with the added expense of full FHA mortgage insurance requirements and you still have to go through the same inspections and draw processes as conventional construction loans.
There is another advantage of FHA loans: the easy refinance option. If mortgage rates drop significantly after your project is complete, you can refinance quickly and easily with minimal paperwork as long as you are always current on your payments and your credit score doesn't plummet.
How Do These Options Compare Side by Side?
Understanding the differences between the three types of loans helps clarify which option is right for you. Here is an easy chart to compare pros and cons of each one at a glance:
| Factor | HELOC | Construction Loan |
|---|---|---|
| Closing Costs | $700 to $2,000 | $12,000 to $15,000 |
| Payment During Construction | Interest only on drawn amount | Principal + interest from day one |
| Time to Close | 3 to 4 weeks | 4 to 6 weeks or longer |
| Prepayment Penalty | None | Varies by lender |
| Appraisal Type | Automated valuation | Full appraisal required |
| Bank Inspections | Not required | Required for each draw |
| Best For | Homeowners with existing equity who plan to pay off quickly | Buyers with limited equity or those keeping property long-term |
When Is a Construction Loan Better Than a HELOC?
We want to be clear: while we see most of our clients succeed with HELOCs, that option is not right for everyone. Different scenarios call for different financing options. A construction loan makes more sense when you do not have enough equity in your home to fund the project, when you are purchasing a new property and adding an ADU simultaneously, or when you plan to hold on to it long term without selling another property. If you fall into one of those categories, the higher upfront costs of a construction loan may be worth it because you need the loan structure it provides.
Which Financing Option Is Right for Your Situation?
The best approach depends on your situation and project. If you have quite a bit of equity in your current home and plan to sell another property after the ADU is finished, a HELOC is almost always the least expensive way to go. Your closing costs are lower, you pay interest only during construction, and can pay off the entire balance as soon as your other property sells with no penalties.
Here's something to think about: If a family member is selling their home to move into the ADU, the HELOC approach usually works the best. You can use the money from the sale of the other home to pay off the HELOC, and you have zero debt from the project.
If you have limited equity but sufficient income, an FHA 203k loan could allow you to finance the project based on the property's future value rather than its current equity. Just understand that you will be refinancing into a whole new mortgage at the current rates.
If you plan to keep the ADU as a long-term rental without selling another property, a construction loan that converts to a permanent mortgage may make more sense for your more long-term financing.
Ready to Talk Through Your Financing Options?
Choosing the right financing is one of the most important decisions you will make when it comes to your ADU project. The good news is that you have options, and most Massachusetts homeowners find that the HELOC path gives them the flexibility and savings they need in order to make the project a success.
At BuildX, we work with trusted mortgage brokers who specialize in ADU financing and can walk you through specific numbers. If you are ready to explore what is possible on your property, schedule a site evaluation and we will help you understand the financing options that are best for your situation.
We work with trusted mortgage brokers who specialize in ADU financing and can walk you through specific numbers for your situation.
Request a Free Consultation or call (781) 627-7000
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