Financing an ADU? Freddie Mac Can Help!

As home prices continue to rise across the country and new construction fails to meet demand, Accessory Dwelling Units (ADUs) are growing in popularity. In fact, the number of yearly ADU applications in California has more than tripled since 2018. Despite the growing interest in building ADUs, options for financing their construction have struggled to catch up.

Now, Freddie Mac—one of the two largest mortgage originators and underwriters—has recognized the need for more flexibility in ADU financing.

In updated financing guidelines released on June 1st, Freddie Mac introduced new borrowing options for properties with existing ADUs, as well as for borrowers who want to build an ADU on their property.

Freddie Mac also updated their glossary to include the term “ADU.” We take this as a sign that lenders are finally recognizing the lasting impact of ADUs on the real estate market.

In the following article, we’ll outline Freddie Mac’s recent ADU financing changes and the impact they’ll have on mortgages and mortgage refinancing moving forward.

Key Takeaways

New changes

• Projected ADU rental income now counts towards mortgage qualification
• Existing CHOICERenovation Mortgage No Cash-Out Loan now available for refinancing temporary ADU funding
• Freddie Mac will now purchase mortgages for 2- and 3-unit properties with ADUs

Loans affected

• Purchase
• Cash-out refinance
• No cash-out refinance

Property Requirements

• Only 1 ADU allowed on the property
• Property may have 1, 2, or 3 primary units and 1 ADU

Timeline

• Though Freddie Mac’s changes are now active, it might take some time for lenders to review and adapt their program offerings to reflect the new policies
• Ask your lender about their ADU financing options

What is Freddie Mac?

Also known as the Federal Home Loan Mortgage Corporation (FHLMC), Freddie Mac was founded in 1970 through the Emergency Home Finance Act in an effort to expand secondary mortgages.

Along with Fannie Mae, Freddie Mac is one of two government-sponsored organizations that purchase, guarantee, and underwrite home loans. Both organizations buy mortgage loans from lenders to help stabilize the mortgage market, thus allowing lenders to continue issuing loans. Freddie Mac typically works with smaller banks, while Fanny Mae purchases loans from larger lenders.

Loan types affected

Freddie Mac’s new ADU financing guidelines apply to the following types of loans:

Purchase

This is the typical mortgage to purchase a new property. Now, Freddie Mac will underwrite mortgages for properties with one, two, or three primary units and one ADU.

Cash-out refinance

Refinance your existing mortgage to cash out on the equity you’ve gained, which can be used to fund ADU construction.

No cash-out refinance

Refinance your existing mortgage to pay off short-term ADU financing, without relinquishing established equity in your home.

Property Requirements

In addition to other qualifying factors (such as DTI, credit score, and sufficient reliable income), there are some property requirements for Freddie Mac’s new ADU financing options:

• The new financing options are only applicable to properties with one ADU. Properties with more than one ADU will not qualify.
• There can be up to three primary dwelling units on the property in addition to the one ADU. Properties with four or more primary units will not qualify.

New ADU Financing Guidelines

1. Projected ADU rental income can now be used to qualify for a loan

Text from Freddie Mac’s ADU financing bulletin:

“Previously, rental income generated from an ADU on a 1-unit Primary Residence could be considered for Mortgage qualification only when the Borrower had a disability and the rental income was from a live-in aide, or when the Mortgage was a Home Possible® Mortgage. We have updated our requirements to allow rental income generated from an ADU on a subject 1-unit Primary Residence to be considered when qualifying the Borrower for a purchase or a “no cash-out” refinance Mortgage, provided that certain requirements are met, including but not limited to:

• The ADU must comply with zoning and land use requirements (legal, legal non-conforming or no zoning)
• An appraisal report must be obtained to support the ADU’s marketability and include at least one comparable sale with an ADU that is rented. If an automated collateral evaluation (ACE) appraisal waiver is offered, it must not be accepted.
• The appraiser’s rental analysis must include a minimum of three comparable rentals that support the market rent of the ADU, and at least one of the comparable rentals must be a property with an ADU
• The Seller must ensure that the ADU rental income used to qualify the Borrower for the Mortgage does not exceed 30% of the total stable monthly income
• At least one qualifying Borrower must participate in a landlord education program or have previous landlord experience for a minimum of one year”
• Rental income that is documented with a lease must not exceed 75% of the lease amount (to account for vacancies and operating expenses).

Takeaway:

If you are purchasing a property with a single home and one ADU, the projected rental income from the ADU can help you qualify for your mortgage (as long as it does not exceed 30% of your total stable monthly income). The appraiser will need to find a minimum of three comparable rental properties nearby, and at least one of the three comparable properties must have an ADU. If you don’t have at least one year of landlord experience, you’ll need to take a landlord education course.

Additionally, if you are looking to use a construction loan to build an ADU, the projected rental income can help you qualify for a Freddie Mac no-cash out refinance once the unit is completed. This refinance essentially converts your construction loan into a mortgage with a better interest rate.

2. Existing CHOICERenovation Mortgage No Cash-Out Loan now available for refinancing temporary ADU funding

Text from Freddie Mac’s ADU financing bulletin:

“We are specifying that our existing CHOICERenovation Mortgage offering provides an option to use a “no cash-out” refinance Mortgage to pay off short-term financing that financed ADU renovations, including the addition or renovation of an ADU, that is completed prior to the Note Date.”

“With the use of Freddie Mac’s CHOICERenovation mortgage, a homeowner can renovate their existing residence to add an ADU or make an ADU renovation part of their home purchase transaction.”

Takeaway:

Renovation mortgage loans can now be used to pay off short-term loans for ADU construction. Funds for ADU construction or renovation can also be included as part of a Freddie Mac home purchase loan.

3. Freddie Mac eligibility for 2- and 3-unit properties with an ADU

Text from Freddie Mac’s ADU financing bulletin:

“Previously, a Mortgage secured by a property with an ADU was eligible for sale to Freddie Mac only if the property was a 1-unit dwelling. In response to recent zoning and ordinance changes in many geographic areas, we have expanded our ADU eligibility requirements to allow one ADU on 2- and 3-unit properties.”

Takeaway:

Before this change, some lenders were reluctant or unable to offer mortgages on two- or three-unit properties that also had an ADU. Now that lenders can sell these loans to Freddie Mac, we’ll likely see more lending options for two- and three-unit properties.

Timeline

While it’s still early, these new developments are very exciting! Lenders are finally acknowledging the value of ADUs and are now offering more financing support.

These changes won’t be in place with all lenders overnight; like any new program, it will take some time for financial institutions to review and adapt their loan offerings to reflect the new policies. Ask your preferred lender about any new ADU financing options they might have available.

Otto ADUs

With these new lending options from Freddie Mac, ADUs are more accessible than ever! If you’re ready to start planning yours, contact Otto. We offer planning, design, permitting, and optional construction management for beautiful and high quality ground-up and garage conversion ADUs throughout the Los Angeles metro area.

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