Background
In March 2017 I purchased my first home for $315K, it was zoned for an ADU. The small 2 bed, 1 bath 800 sf brick structure required a full remodel and had an additional 800 sf unfinished basement. Before I moved in, I remodeled the main level, investing $60K. In summer 2018 I spent $40K to finish the basement – adding a master suite making the home 3 bed, 2 baths. The improvements were part of a thoughtful plan to add equity to my home in order to finance a future ADU (accessory dwelling unit). In January 2020 I engaged an architect to design the ADU and we submitted to the City of Denver mid-2020 for a permit. In December 2020 the city approved our permit and I began working with a lender to finance the project.
Construction Loan for an ADU
Before you contact a lender, you need to have your architectural plans completed, approval of the permit from the city, and select the builder you plan to work with. The builder will use the plans from your architect to come up with a detailed bid – the bid and plans must be in place to get a construction loan. The construction bid to build my ADU is $360K FirstBank is well known in the Denver community for construction loans and I went with them based on a recommendation from my builder and knowing their good reputation. I loved working with Megan MacHatton, she was excellent!! Luckily with my income, I was fortunate enough to qualify for a construction loan. When I initially purchased the home in 2017 my mom had to co-sign with me. She needed taxes for the last two years, bank statements, etc. I had to up my insurance to cover the construction project in my backyard. We talked numbers, but nothing could be determined until we had an appraisal done.
Appraisal
Appraising an ADU presents many challenges. ADUs are very uncommon in the Denver market because the concept started in 2010. Of the 200 ADUs built, most owners keep them and therefore true market value is not well established. In my appraisal, they had one good comp that sold for $806K with an ADU and he used another sale 6 miles SW in Overland for $925K with an ADU. He also considered one property with a basement ADU that sold for $750K. Lastly, he used two properties similar to the existing main house without ADUs that had sold for $538K and $549K and adjusted them $240K to account for the ADU. The appraised value ended up at $770,000 for the main house plus the ADU. Unfortunately, this is not good because I know that the main house is worth at least $540K and I’m planning to spend $360K building the new ADU. Ideally, the appraisal would be at least $900K (value of the main house + cost of constructing the ADU). Luckily, I was prepared for the low appraisal as it is commonplace with ADUs.
Financing
FirstBank will give you a construction loan for 80% of the appraised value – so my loan is for $616K (80% of $770K appraised value). They carried the loan for the entire property, so they paid off and took over the $271K loan on the primary house plus the $360K loan for construction of the ADU. It’s a $616K interest only, one year loan with a balloon payment due after 12 months. My interest rate is 4%. My payments start at $945/m and as the builder takes draws on the loan, the monthly payment will max out at $1890/m. I currently rent the main house for $2300/m so the mortgage is sufficiently covered during construction. Because the appraisal came in low, I had to bring a $23K down payment to closing and my closing costs were $5K. We estimate construction to take 6 months. After construction, I plan to refinance the home into a traditional 30-year mortgage at a lower interest rate and I’m crossing my fingers that after completion I can get a better appraisal at that time.
