Best type of loan to build an ADU

[Tony Dinh]

I have an investment property that is fully paid off in garden grove California. I plan on doing some renovations to the main house and building an ADU.

I wanted to see what would be the best type of loan that I should be looking into. In terms of potential tax write offs and savings? HEL, HELOC?

[Matthew Bernal]

🔹 Best Loan Options for Building an ADU in Garden Grove, CA 🔹

Great question! Since you own the property free and clear, you have several financing options to consider. Each has different advantages depending on your tax strategy, cash flow goals, and risk tolerance.

🏡 1. Home Equity Loan (HEL) – Best for Fixed Rates & Predictability

A Home Equity Loan (HEL) lets you borrow a lump sum against your home’s equity at a fixed interest rate. This is a solid option if:

✅ You want predictable monthly payments

✅ You’re looking for a one-time financing option for ADU construction

✅ You prefer a longer repayment period (10-30 years)

🔹 Potential Tax Benefit: Interest may be deductible if the loan is used for substantial improvements to the property. Consult your CPA to confirm.

💳 2. Home Equity Line of Credit (HELOC) – Best for Flexibility

A HELOC gives you a revolving line of credit based on your home’s equity. Think of it as a credit card secured by your property with a variable interest rate. Great if:

✅ You want flexibility and only borrow what you need

✅ You plan to do construction in phases

✅ You want interest-only payments during the draw period

⚠️ Risks: Since HELOCs have variable interest rates, your payment can increase if rates rise.

🔹 Tax Benefit? Similar to a HEL, interest is potentially deductible if funds are used for home improvements.

🏗️ 3. Cash-Out Refinance – Best for Low Interest Rates

With a cash-out refinance, you replace your existing mortgage (which you don’t have) with a new loan for a higher amount, pocketing the difference. This works well if:

✅ You want one mortgage payment instead of multiple loans

✅ You can lock in a low, fixed rate

✅ You plan to invest in additional renovations beyond the ADU

⚠️ Downside? You’ll start a new mortgage with closing costs, so it’s not always the best option unless you’re borrowing a large amount.

🏦 4. Construction Loan – Best for Larger Projects

If you’re building a high-end ADU, a construction loan may be a good option. These are typically short-term, interest-only loans that convert to a traditional mortgage upon project completion. Best if:

✅ You want funds disbursed in stages to control costs

✅ You plan to significantly increase property value

⚠️ Downside? These loans can have higher rates and require more paperwork.

📌 Final Thoughts: What’s the Best Option?

If you need a lump sum with a fixed rate → Home Equity Loan ✅

If you want flexibility to borrow as needed → HELOC ✅

If you want to refinance and access equity at a low rate → Cash-Out Refi ✅

If you plan a large-scale project → Construction Loan ✅

💡 Pro Tip: Talk to your lender and a CPA to ensure you’re maximizing tax benefits and choosing the best loan structure for your long-term goals. If you’re planning to rent the ADU, a HELOC or cash-out refi could be great options since interest may be deductible as a rental expense.

Would love to hear what others in the community have done for their ADU financing! 🚀