I don’t know about where you live, but here in Marin County, accessory dwelling units (“ADU”), also known as accessories, 1+’s, granny units, in-law’s, mother-in-law’s, etc., are all the rage. When we discuss remodel projects with our clients, adding an accessory is often high on the list. After all, if permitting allows, the thought of having the extra space to accommodate guests, parents or children, short- or long-term renters or maybe just create the proverbial doghouse in marriage under the strain of any/all of the above, can be appealing. But from a mortgage guideline standpoint, if you have or build an ADU, can you use the rental income it may generate in order to help you qualify for a home loan?
Get in the Zone
In order to answer our question about qualifying income, we have to address two key elements first:
- What is the legal description of the home?
- What type of loan are you seeking to obtain?
Let’s take a look at the first question from both the angle of the legal description of the property and also the method by which an appraiser might likely approach the opinion of value. It’s safe to say that if the property was built as a single family dwelling (SFD or SFR — for “residence”), adding an ADU will not change that. Usually the footprints of the structures will be sufficiently different such that the property would always be viewed as an SFD. When a second structure is built on one lot, per zoning requirements of course, and that home becomes a true second residence (different address, different utility meters, etc.), now we may be looking at a legal duplex instead. But for the scope of our conversation, let’s stick to the 1+ scenario. When an appraiser is hired to complete a report on an SFR with an accessory, he or she will check a box on the report that shows the property is a “1+” and the report will be done on a 1004 form (as opposed to the appraisal form 1025, which is used for 2, 3 and 4 units).
Now traditionally, if you have sought a mortgage for a legal 1-unit property, even with an accessory, and that home was your primary residence, lenders would NOT allow you to use the rental income in the qualification process. Boarder income (room rents), short-term rentals (AirBnB, VRBO, etc.) and even rents resulting from legitimate lease agreements on an ADU were a dead-end. This proved problematic for both buyers and owners of these properties because often the ADU, and its income-producing properties, were important characteristics in the desirability of the home itself. Absent categorization of the property as a legal 2-unit, rental income was out and borrowers had to qualify with employment-based income primarily. To further the confusion, some buyers would think they were buying a duplex, which has a higher conforming loan limit, and base their down payment and other terms off of that assumption, only to have their hopes dashed when they learned the home is legally an SFR with an accessory. As with many things in the inherently complex world of real estate, the grey area could be vast and the consequences serious.
Conforming loan programs (save for HomeReady) still adhere to the approach above, but there are some very promising options for the use of rental income if you require a jumbo mortgage. For the most part, we have really strong options for the inclusion of rental income from an ADU with a number of jumbo investors. The gold standard tends to be that the rental income must have been declared on the borrower’s tax returns for the last two years. In short, a history is required to document stable income production from the ADU. Now as you might suspect, this is going to preclude a purchase loan, where the buyer would not be able to produce such a history. In that case, we have another investor that not only accommodates ADU income on a purchase, but will use an appraiser’s opinion of market rent for the unit (as opposed to requiring a lease agreement).
ADU, short-term rentals and boarder income are all a reality in many markets. And the trend appears to be increasing in terms of the popularity of these property and the financial benefits they can bestow to the owner/borrower. It’s also a fact that not all mortgage lenders have the programs that will take this income into consideration and have it work to the borrower’s advantage. We are one of the lenders who will and if you have any questions about the generation and use of the rental income from your one-unit, primary home, give me a call any time.
ADU 4 U n Me,
Marin Office: 324 Sir Francis Drake Blvd., San Anselmo, CA 94960
Berkeley Office: 1400 Shattuck Ave., Suite 1, Berkeley, CA 94709
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