ADU Financing Options (2025): HELOC vs Cash-Out vs Construction Loans

HELOC: flexible and fast

A home equity line of credit functions like a reusable checkbook backed by your equity. You draw funds as you need them for design fees, surveys, permits, and progress payments. During the draw period, many HELOCs allow interest-only payments, which keeps cash flow light while you build. Once the ADU is complete, you can continue using the line for upgrades or pay it down with rental income.

• Upside: Quick access, you only pay interest on what you use, and you can match draws to your contractor’s schedule.
• Watchouts: Variable rates can rise. Some lenders limit draws near the end of the draw period, and lines can be reduced if values fall.
• Good fit when: You have solid equity, want speed, and prefer flexibility over long-term rate certainty.

Cash-out refinance: one fixed payment

With a cash-out refi, you replace your current mortgage with a new, larger one and take the difference in cash at closing. You get a single fixed rate and one payment. Owners choose this when they’d like to lock a rate and simplify budgeting.

• Upside: Fixed payment predictability; no separate second lien.
• Watchouts: You restart the mortgage clock and pay closing costs on the full balance. If your current rate is low, replacing it may be costly.
• Good fit when: You’re comfortable resetting your mortgage and want a one-payment plan with fixed terms.

Construction loan: purpose-built for new ADUs

Construction loans are designed for ground-up builds and major conversions. Funds are released in draws tied to milestones (foundation, framing, rough-in, finishes). Inspections verify progress before each draw. Many products convert to a permanent mortgage at completion; others require a refinance. During construction, payments are often interest-only on the amount drawn.

• Upside: Built for contractors, draw schedules, and inspections; can cover soft costs and contingencies.
• Watchouts: More paperwork and time. Requires a detailed budget, plans, and signed contracts. Appraisals may use “as-completed” value.
• Good fit when: You’re doing a full ADU build with a licensed GC and clear schedule.

FHA 203k: renovation-friendly for eligible projects

The FHA 203k program can fund renovations (including eligible garage conversions) under FHA guidelines. It’s attractive to some first-time buyers and owners with limited down payment, but it carries extra steps: using FHA-approved lenders, working with a 203k consultant, and meeting scope limits. Draws are disbursed after inspections.

• Upside: Access to FHA terms; pairs well with renovation scopes.
• Watchouts: Extra process and fees, capped scopes, and property eligibility rules.
• Good fit when: Your ADU is part of a broader renovation and you qualify for FHA.

Watch: short explainer clips

How to choose in 20 minutes

1. Check equity and cash cushion. If you need staged access and speed, shortlist a HELOC or construction loan.
2. Decide on rate certainty. If a fixed payment matters most, explore cash-out or fixed construction-to-perm options.
3. Align to your build plan. If you have a GC, plans, and a draw schedule, a construction loan fits the process.
4. Map the monthly payment. Use the calculator to test a 6–12 month interest-only window during construction.
5. Compare total cost of capital. Include lender fees, points, required reserves, inspections, and conversion/refi costs.
6. Sanity-check your rent or savings. If renting, pencil conservative rents and 5–10% vacancy. If for family use, weigh value and flexibility over cash return.

When you have two finalists, request written estimates on the same day so rate environments are comparable. Ask for both payment and APR (annual percentage rate, which includes certain fees). Then choose the pairing of timeline and paperwork you can live with.