What it is: From the point that a person buys a house, they will have a certain amount of equity, money that’s available from lenders based on the value of the property. A cash-out refinance allows a person to take a loan in order to build an accessory dwelling unit using their home equity, while also refinancing their mortgage.
This type of loan is relatively straightforward compared to certain other types of ADU financing that can be more complex. Cash-out refinances can close in as little as 30 days if someone has sufficient income, property appraisal, and credit, according to Traci Stier, a Santa Ana-based mortgage broker for Arbor Financial.
“If you’re getting a refinance loan, we don’t care that you’re going to use that money, the cash-out refinance proceeds, to build an ADU,” Stier told ADU Magazine. “You’re a free agent, you’ve got the money, and now you can choose to pay 100% for the contractor before they break ground if you want to.”
Cash-out refinances are arguably one of the most popular methods for financing accessory dwelling units. As such, there are several advantages.
Aside from the lack of restriction on how the money gets used and the closing period for the loan, which mirrors closing times for conventional mortgages, Stier notes that for people who have owned their homes longer, a cash-out refinance “might be the cheapest money.”
It also can be a good time for homeowners to do cash-out refinances to build an ADU, based both on mortgage interest rates having fallen to historic lows in recent years and homes having appreciated in value to near-historic highs. Homeowners who do cash-out refinances in the near term should be able get new loans at low rates while tapping into equity they didn’t know they had.
With ADUs able to add durable value to a property, cash-out refinances can be a cost-effective way to do it at the current time.
While cash-out refinances can be a good tool for homeowners to finance an ADU addition to their property, there are a few disadvantages to be mindful of.
First, as Rocket Mortgage notes, “If you qualify for it, cash-out refinancing typically offers better interest rates, but may have higher closing costs.” This means anyone applying for a cash-out refinance might need to bring more cash to the loan signing.”
They’ll also want to have a credit score ideally at least in the 720 range, said Robert Huibers, Movement Mortgage branch manager for San Mateo County, Calififornia. “You can still get something at 680-plus,” Huibers told ADU Magazine. “But anytime you go below 680… you’re going to be paying quite a bit of extra fees, or points, if you will.”
Cash-out refinances also could start to seem like a far less appealing option if interest rates rise, as the U.S. Federal Reserve has signalled could happen in 2022.
Any homeowner who currently has a three percent interest rate for their mortgage might think a lot harder about whether they really want to build an ADU if the cost is having a mortgage a few interest points higher. It can cost tens, if not hundreds, of thousands of dollars more in compound interest over the life of the mortgage.