ADU - a small house built on property with larger house on it

Rental income from ADUs now can be counted toward an FHA mortgage 

Starting this week, the FHA has tweaked its borrowing rules to promote accessory dwelling units as a way to boost housing inventory and affordability.

October 17, 2023
3 minutes

Key points:

  • ADUs are smaller, typically detached residences that homeowners can build on the same property as their primary residence.
  • Rules around ADUs vary. There has been an ADU boom in California; Denver and Chicago also allow them.
  • HUD’s chief said that “increasing the supply of affordable housing and helping families to create generational wealth” are primary reasons for making the changes.

Homeowners who are looking to add an accessory dwelling unit (ADU) to their property or want to refinance their home and existing ADU now have another lending option. 

Starting this week, the Federal Housing Administration has expanded financing to borrowers who have either already built an ADU — sometimes referred to as a "granny flat" or coach house — or are seeking to build one on their property.

What is an ADU?

ADUs are typically smaller, detached units built behind a primary residence or above a garage. They can be used for a family who wants extra space for visitors or a home office, they can be utilized as short-term or long-term rentals for additional income, or can be a solution for older homeowners who wish to "age in place" and downsize without selling their house. 

The legality of what qualifies as an ADU — and the process to build one — varies from state to state and city to city

The push for ADUs has been most visible in metros and states where high housing costs have pushed homeownership out of reach for many. Over 23,000 ADUs were permitted across California in 2022, according to a Washington Post story from May, while they have also become popular in Denver, Chicago, and Tucson.  

Just last month, the Phoenix City Council approved the construction of new ADUs. And then just this week, the State of California signed a new law that allows people to buy and sell ADUs like condos.  

FHA loans now available to ADUs

The venerable FHA loan has been the workhorse of the small-time real estate investors and regular homebuyers on a tight budget. FHA loans allow borrowers to put down as little as 3.5% of the purchase price of the home at closing, bringing down one of the primary barriers to entry for homeownership.

According to the White House, the FHA has "supported nearly 1.8 million homeowners with purchase mortgages" where nearly 84% — or 1.5 million of these borrowers — were first-time homebuyers.

Including income from ADUs or allowing borrowers to take on a 203(k) Rehab loan with additional funds intended to be used towards the construction of a new ADU is designed to help ease the affordability crisis and make homeownership more accessible, HUD Secretary Marcia L. Fudge said in the announcement.

"Increasing the supply of affordable housing and helping families to create generational wealth is what today's action making it easier to finance an accessory dwelling unit is all about," she said. "This is a part of our work to help address the critical shortage of affordable housing in communities across the country and help people increase the value of their homes."

There are stipulations, however. Only 75% of the estimated rental income on an existing ADU will be included in the borrower's debt/income ratio, while borrowers seeking additional funds to build a new ADU via a 203(k) loan will only be able to include 50% of the estimated rental income in their calculation.

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