Learn all about financing options for SB 9 projects.
Senate Bill 9 gives California homeowners the legal right to build additional residential units on their property. However, the law doesn’t provide them with a clear path for financing these projects. Because SB 9 is such new and unprecedented legislation, financial institutions have yet to establish standard practices for financing the kinds of small-scale, homeowner-led housing developments that the new law will usher in.
In the following guide, we'll explore the financing options that currently exist for funding SB 9 projects and help you understand which type of financing is best for you.
SB 9 Financing Options
Currently, there are three main avenues for funding an SB 9 project: cash-out refinancing & construction loans.
A cash-out refinance is a type of mortgage refinance that allows a homeowner to exchange some of the equity they've built up in their home for a cash payment in the form of a lump sum, which can be used to fund SB 9 projects.
How it works
Unlike taking out a second mortgage, which adds an additional monthly payment, a cash-out refinance replaces your old mortgage with a new one. This feature is attractive for many qualifying homeowners who prefer the convenience of a single monthly payment.
- Lower interest rates (compared to those for other borrowing options, e.g. credit cards, construction loans, etc)
- High borrowing power allows homeowner to borrow up to 80% of their home’s current value
- Consolidation of mortgage and construction financing into a single loan
- Lump sum payment makes funds available immediately
- Accessible funds might not be sufficient. Building a new home or duplex can cost hundreds of thousands of dollars, and many homeowners do not have enough equity built up to fully cover the costs of their project.
- Must have a low DTI (Debt-To-Income) ratio. Cash-out refinancing necessitates that your total debt payments (credit cards, student loans, car payments, etc.) are less than 45%-50% of your gross income. In an expensive state like California, this is difficult for most homeowners to achieve.
In short, cash-out refinancing can be a good option for homeowners who have a lot of equity built up in their home and want to consolidate their monthly payments. But if you haven’t built up much equity yet or your monthly debt-to-income ratio is too high, a cash-out refinance might not work for you.
Construction loans are short-term loans specifically for new construction or home improvement projects–including building an additional dwelling unit on one’s property.
How it works
While traditional refi loans are determined by the current value of one’s home, construction loans are distinctive because they allow homeowners to borrow against the projected value of their home once renovations are complete. This makes the construction loan an attractive option for recent home buyers and others who have yet to build much equity.
Construction loans also come with their share of drawbacks which one must take into consideration. These loans are subject to tighter regulations and require extra bank oversight when compared to other financing options.
For example, the bank must approve the contractor you've hired before they'll approve your loan. The bank also wants to see surveys, lot subdivision maps, city approvals, blueprints, building permits, and contracts for all estimates in the building process before approval. That’s a lot of expensive legwork to undertake before the financing is even secured!
Furthermore, many contractors are hesitant to work with homeowners who use these loans because they require extra oversight from the bank and money is only released at certain construction milestones. In order to take out a construction loan, you have to have the ability to either fully repay or refinance the loan within two years, which can be limiting. In addition to the aforementioned obstacles, construction loans carry higher closing costs than refi loans and require low DTIs and high credit scores in order to qualify.
- Higher borrowing power than traditional refi loans
- Not dependent upon established equity
- Higher closing costs and interest rates than refi loans
- Must have low DTI (<43%) and high credit (700+) to qualify
- Project must be completed within projected timeline
- Must repay or refinance within a fixed period (usually 2 years or less)
- Multiple hoops to jump through prior to bank approval
- Cash isn’t accessible all at once, as funds are portioned out and released only at certain points in the construction process
- Extra oversight and restrictions make some contractors reluctant to sign on
Construction loans are only advisable for homeowners with low home equity, as higher closing costs and increased oversight and limitations are definite drawbacks. And if your debt-to-income ratio is too high or your credit score too low, you might not qualify.
Construction Loan Hack: CalHFA ADU Grant Program
If part of your SB 9 plans include an ADU construction and you’re interested in pursuing a construction loan, you might want to consider the California Housing Finance Agency’s grant program. Qualifying homeowners can receive a grant of up to $40,000 to help pay for predevelopment costs associated with ADU construction. While it certainly won’t cover the cost of construction, it will help to lower it.
SB 9 is still very new, and it remains to be seen how different cities and municipalities will interpret and implement the law. As time goes on, it's quite possible that additional financing options will emerge and allow homeowners even more possibilities for financing their projects.