HELOC, cash-out refi or renovation loan: paying for an ADU.

Three loans cover most ADU projects in Washington. They differ in one important way: what they do to the mortgage you already have. Pick the one that keeps the most valuable thing you own, often a low first-mortgage rate, and still pays for the build. This is general information, not lending advice.

The quick comparison

HELOC: keep the first mortgage

A home equity line of credit is a revolving line secured by your home. You draw when invoices arrive and pay interest only on what you have used, which fits a project paid in stages. It leaves your first mortgage alone, which matters if its rate is lower than today’s. The limit is the problem: it is based on your equity now, without the ADU, so it may fall short on an expensive backyard cottage.

Cash-out refinance: one new loan

A cash-out refinance replaces your mortgage with a larger one and pays you the difference. One loan, one payment, and often a fixed rate. It only makes sense when the new rate is close to or below your current one, because the new rate applies to the whole balance, not just the ADU money. You also receive the cash up front and pay interest on all of it from day one.

Renovation loan: borrow against what you’re building

Renovation mortgages, such as Fannie Mae’s HomeStyle Renovation or FHA’s 203(k), size the loan on the value of the home with the finished ADU. That is how owners with modest equity can still build. The trade-offs are paperwork and control: the lender approves the contractor’s bid and plans, and releases money in draws after inspections.

These programs can also count the ADU’s rent toward qualifying:

• FHA lets lenders use 75% of estimated rent from an existing ADU, and 50% of projected rent from a new ADU added under the Standard 203(k).
• Fannie Mae allows ADU rental income on a one-unit principal residence for purchases and limited cash-out refinances, capped so it does not exceed 30% of total qualifying income.

Three situations

Low first-mortgage rate, plenty of equity

A HELOC, possibly with savings for design and permits. Keep the cheap mortgage.

Rates now similar to yours, equity enough

A cash-out refinance can simplify things into one fixed payment.

Not enough equity today

A renovation loan, which borrows against the finished value and can count the ADU’s rent. Expect more steps and a longer approval, and start early.

Whatever you choose, design, survey and permit fees usually come before any construction money. Budget them from savings or a credit line.

The full picture, including draw schedules and the costs owners forget, is in Paying for an ADU.