How to Finance an ADU With a Home Equity Line of Credit

Using a HELOC to Finance Your ADU Project

A Home Equity Line of Credit (HELOC) is one of the most popular and practical ways to finance Accessory Dwelling Unit (ADU) construction in California. By leveraging the equity you have built in your home, a HELOC allows you to access funds as needed throughout the construction process, pay interest only on the amount you have drawn, and potentially deduct the interest on your taxes.

For California homeowners, where property values are high and substantial equity has often accumulated, a HELOC can provide the flexible financing needed to fund an ADU project from start to finish. This guide covers everything you need to know about using a HELOC for your ADU, from qualification requirements to strategic draw schedules and beyond.

How HELOCs Work for ADU Financing

A HELOC is a revolving line of credit secured by your home. Unlike a traditional loan that provides a lump sum, a HELOC gives you access to a credit line that you can draw from as needed during a specified period, typically 5 to 10 years (the draw period).

Key HELOC Features

Why HELOCs Work Well for ADU Construction

HELOCs are particularly well suited for ADU construction because of their flexible draw structure. ADU construction costs are incurred incrementally over several months, not all at once. With a HELOC, you draw funds as invoices come due, meaning you only pay interest on money you have actually used. This can save thousands of dollars in interest compared to a lump-sum loan where you would be paying interest on the full amount from day one.

Additionally, because HELOCs are secured by your home, they typically offer lower interest rates than unsecured construction loans or personal loans. And since you are using the funds for home improvement, the interest may be tax-deductible (consult with a tax professional for specifics).

Qualifying for a HELOC for ADU Construction

Lenders evaluate several factors when determining whether to approve a HELOC and how much credit to extend.

Home Equity Requirements

You need sufficient equity in your home to qualify for a HELOC. Most lenders require a combined loan-to-value (CLTV) ratio of no more than 80% to 85%. This means your existing mortgage balance plus the HELOC credit line cannot exceed 80-85% of your home's current appraised value.

For example, if your home is appraised at $1,000,000 and your mortgage balance is $500,000, your available equity for a HELOC at 80% CLTV would be $300,000 ($1,000,000 x 80% = $800,000 minus $500,000 = $300,000). In many California markets, this provides more than enough to fund an ADU project.

Calculation Example

Credit Score Requirements

Most lenders require a minimum credit score of 680 for HELOC approval, though some may accept scores as low as 620 with higher interest rates. The best rates are typically reserved for borrowers with credit scores of 740 or higher. Before applying for a HELOC, check your credit score and address any issues that might lower it.

Debt-to-Income Ratio

Lenders evaluate your debt-to-income (DTI) ratio, which compares your monthly debt payments to your gross monthly income. Most lenders prefer a DTI of 43% or less, though some may accept higher ratios for borrowers with strong credit and significant equity. Your DTI calculation includes your mortgage payment, car loans, student loans, credit card minimum payments, and the projected HELOC payment.

Income Verification

You will need to document your income through recent pay stubs, tax returns (typically two years), W-2 forms or 1099s, and bank statements. If you are self-employed, you may need to provide additional documentation such as profit and loss statements and business tax returns.

Understanding HELOC Interest Rates

HELOC interest rates are typically variable, meaning they can change over the life of the credit line. Understanding how these rates work helps you plan your finances and manage costs.

How HELOC Rates Are Determined

Most HELOC rates are based on the prime rate (which is tied to the Federal Reserve's federal funds rate) plus a margin determined by the lender based on your creditworthiness. For example, if the prime rate is 7.5% and your margin is 1%, your HELOC rate would be 8.5%. As the prime rate changes, your HELOC rate changes accordingly.

Current Rate Environment

As of early 2026, HELOC rates in California typically range from 7.5% to 10.5%, depending on the lender, your credit score, and the amount of equity you are borrowing against. Rates have been influenced by Federal Reserve policy and broader economic conditions. Shop multiple lenders to find the best rate for your situation.

Fixed-Rate HELOC Options

Some lenders offer fixed-rate HELOC options that allow you to lock in a portion of your balance at a fixed rate. This can provide payment predictability for your ADU construction costs while still maintaining the flexibility of a variable-rate line for other draws.

Rate Caps

Most HELOCs have rate caps that limit how much the interest rate can increase over the life of the credit line and during any single adjustment period. Common lifetime caps are 18% to 21%, and periodic caps typically limit increases to 2% per adjustment period. Review the rate cap structure carefully before choosing a lender.

Strategic Draw Schedule for ADU Construction

Planning your HELOC draws to align with your construction schedule minimizes interest costs and ensures funds are available when needed.

Typical ADU Construction Draw Schedule

By drawing funds only as needed, you minimize interest costs. For example, instead of drawing the full $200,000 at the start of the project and paying interest on the entire amount for 10 months, you draw incrementally and pay interest only on the cumulative amount drawn. This strategy can save $5,000 to $10,000 or more in interest over the course of a typical ADU construction timeline. Learn more about ADU construction timelines in California.

HELOC vs. Other ADU Financing Options

While a HELOC is an excellent choice for many homeowners, it is worth comparing it to other ADU financing options in California.

For a detailed comparison of construction-specific financing, see our article on ADU construction loans vs. home improvement loans.

Tax Implications of Using a HELOC for ADU Construction

The Tax Cuts and Jobs Act of 2017 changed the rules for deducting HELOC interest. Under current law, HELOC interest is tax-deductible if the funds are used to "buy, build, or substantially improve" the home that secures the loan. Building an ADU generally qualifies as a substantial improvement, making the interest potentially deductible.

Requirements for Deductibility

To deduct HELOC interest used for ADU construction, you must itemize your deductions rather than taking the standard deduction, the total mortgage debt (including the HELOC) must be under $750,000 for married filing jointly or $375,000 for single filers, and the funds must be used for qualified home improvement (ADU construction qualifies). Keep detailed records of how HELOC funds are used, including invoices, receipts, and bank statements showing draws and payments to contractors.

Tips for Successfully Using a HELOC for Your ADU

Shop Multiple Lenders

HELOC rates, fees, and terms vary significantly between lenders. Get quotes from at least three to five lenders, including your current mortgage lender, local banks and credit unions, and online lenders. Pay attention to closing costs, annual fees, and rate margins in addition to the initial interest rate.

Get Your HELOC Approved Before Starting the Permit Process

The HELOC approval process can take 30 to 60 days. Start the application process well before you need the funds. Having your financing in place before applying for permits demonstrates that you are a serious and prepared homeowner.

Maintain a Reserve

Do not draw the full HELOC amount for ADU construction. Maintain a reserve of at least 10-15% for unexpected costs, which are common in construction projects. This reserve provides a financial cushion for change orders, material price increases, and unforeseen site conditions. Understanding ADU costs in California helps you budget appropriately.

Plan for Repayment

Have a clear plan for repaying the HELOC. If you plan to use ADU rental income for repayment, calculate the monthly payment during the repayment period (when you will be paying both principal and interest) and ensure the rental income can cover it with room to spare.

Risks of Using a HELOC for ADU Construction and How to Mitigate Them

While a HELOC is an excellent financing tool for ADU construction, it comes with risks that you should understand and plan for before committing.

Variable Interest Rate Risk

Most HELOCs carry variable interest rates tied to the prime rate. If interest rates rise significantly during your draw period or before you repay the loan, your monthly payments could increase substantially. To mitigate this risk, consider choosing a HELOC with a rate cap that limits how high your rate can go. Some lenders offer the option to convert a portion of your HELOC balance to a fixed rate, providing payment predictability. You can also accelerate repayment when rates are low to reduce your outstanding balance before potential rate increases.

Risk to Your Home

A HELOC is secured by your home. If you are unable to make payments, you risk foreclosure. This is the most significant risk of using a HELOC for ADU construction. To protect yourself, never borrow more than you can comfortably repay even without rental income from the ADU. Maintain emergency reserves of at least six months of payments. Consider whether you could afford the payments if you lost your primary income or if the ADU were vacant for an extended period.

Construction Cost Overruns

ADU construction projects frequently exceed their initial budgets due to unforeseen site conditions, material price fluctuations, permit delays, and design changes. If your HELOC credit limit does not cover the increased costs, you could be left with an incomplete ADU and no additional financing to finish it. Mitigate this by maintaining a contingency reserve of 15% to 20% of your budget within your HELOC credit line, working with an experienced ADU builder who provides detailed cost estimates, and getting fixed-price contracts where possible.

Market Value Risk

If property values decline after you have drawn on your HELOC, you could end up owing more than your home is worth (being "underwater"). While this does not affect your ability to repay the HELOC, it limits your future borrowing options and could create problems if you need to sell. California's real estate market has historically been resilient, but regional and local conditions can vary. Research the expected return on investment for ADUs in your area before committing to a HELOC.

Step-by-Step HELOC Application Process for ADU Projects

Understanding the HELOC application process helps you prepare properly and avoid delays.

Step 1: Check Your Credit and Financial Profile

Before applying, review your credit reports from all three bureaus (Equifax, Experian, TransUnion) and correct any errors. Calculate your debt-to-income ratio and verify your home equity position. Address any credit issues at least 60 to 90 days before applying to allow time for corrections to be reflected in your reports.

Step 2: Research and Compare Lenders

Contact at least three to five lenders including your current mortgage holder, local banks, credit unions, and online lenders. Request detailed rate quotes that include the margin above prime, any introductory rates, annual fees, closing costs, and draw and repayment terms. Use a spreadsheet to compare the total cost of each option over a 10-year period.

Step 3: Submit Your Application

Once you have chosen a lender, submit your application with all required documentation. Be prepared to provide two years of tax returns and W-2s, recent pay stubs or proof of income, current mortgage statements, homeowner's insurance declaration page, and photo identification. Having all documents ready upfront prevents delays in the approval process.

Step 4: Home Appraisal

The lender will order an appraisal to determine your home's current market value. The appraised value, minus your existing mortgage balance, determines your available equity and maximum HELOC amount. Prepare your home for the appraisal by making necessary repairs and improvements. Learn more about the appraisal process in our guide to getting the best ADU appraisal in Los Angeles.

Step 5: Underwriting and Approval

The lender's underwriting team reviews your application, verifies your documentation, and makes a lending decision. This process typically takes two to four weeks. Be responsive to any requests for additional documentation to avoid delays.

Step 6: Closing

Once approved, you will review and sign the HELOC agreement, pay any closing costs, and receive access to your credit line. After the three-day right of rescission period required by federal law, you can begin drawing funds.

Real-World HELOC ADU Financing Example

To illustrate how a HELOC works for ADU financing, consider this realistic California scenario.

The Setup

Maria owns a home in the San Fernando Valley valued at $950,000 with a remaining mortgage balance of $380,000. She wants to build a 600-square-foot detached ADU in her backyard with an estimated construction cost of $220,000.

HELOC Calculation

Maria's lender offers a HELOC at 80% CLTV. Her maximum total borrowing is $760,000 (80% of $950,000). After subtracting her existing mortgage of $380,000, she qualifies for a HELOC of up to $380,000, more than enough to cover her $220,000 ADU project with room for contingencies.

Draw Schedule

Maria draws $20,000 for design and permits in month one, $35,000 for site preparation and foundation in month four, $70,000 for framing and rough systems in months five through seven, $65,000 for interior finishes in months seven through nine, and $20,000 for final touches in month ten. Her total draws equal $210,000, leaving $10,000 of her $220,000 budget as reserve.

Monthly Costs During Construction

At a 9% HELOC rate, Maria's interest-only payments during the draw period average approximately $750 per month as her balance gradually increases. Once the ADU is complete and she rents it for $2,200 per month, the rental income more than covers her HELOC payments while also providing cash flow for property taxes and maintenance.

Combining a HELOC With Other Financing Sources

Some homeowners combine a HELOC with other financing options to optimize their ADU funding strategy. Understanding these combination approaches can help you minimize costs and maximize flexibility.

HELOC Plus CalHFA Grant

The California Housing Finance Agency (CalHFA) has offered grants of up to $40,000 for ADU construction. If you qualify, this grant can reduce the amount you need to draw from your HELOC. For example, if your ADU costs $200,000, using a $40,000 grant means you only need to draw $160,000 from your HELOC, saving approximately $3,600 per year in interest at a 9% rate.

HELOC Plus Personal Savings

Using personal savings for the initial phases of ADU construction (design, permits, and site preparation) and then drawing on your HELOC for the larger construction costs can reduce your overall interest expense. If you can fund the first $30,000 to $50,000 from savings, you delay the start of HELOC interest charges by several months and reduce your total borrowing.

HELOC for Construction, Then Refinance

Some homeowners use a HELOC to fund ADU construction and then refinance into a fixed-rate home equity loan or cash-out refinance once the ADU is complete and the property's value has increased. This strategy allows you to take advantage of the HELOC's flexible draws during construction while securing a more predictable fixed rate for long-term repayment. The post-construction appraisal should reflect the increased property value from the completed ADU, potentially giving you access to better refinancing terms.

Frequently Asked Questions About Financing an ADU With a HELOC

How much can I borrow with a HELOC for ADU construction?

The amount depends on your home's appraised value, your existing mortgage balance, and the lender's maximum CLTV ratio (typically 80-85%). In California, where home values are high, many homeowners can access $200,000 to $400,000 or more through a HELOC.

Can I get a HELOC if I still have a mortgage?

Yes. A HELOC is a second lien on your property, so it can coexist with your first mortgage. The combined balance of your mortgage and HELOC must not exceed the lender's maximum CLTV ratio.

Is HELOC interest tax deductible for ADU construction?

Generally yes, if the funds are used to build or substantially improve your home (which ADU construction qualifies as). However, you must itemize deductions, and the total mortgage debt must be under the applicable limit. Consult with a tax professional for guidance specific to your situation.

What happens if my home value decreases after I get a HELOC?

If your home value decreases, your lender may reduce your credit limit or freeze the line. This is one risk of variable-rate, equity-based lending. To mitigate this risk, avoid borrowing the maximum amount and maintain a healthy equity cushion.

Can I use a HELOC for both ADU construction and other expenses?

Yes. A HELOC is a flexible line of credit, and you can use the funds for any purpose. However, only the portion used for home improvement qualifies for the interest tax deduction. Keep separate records of draws used for ADU construction versus other purposes.

How quickly can I get a HELOC approved?

The typical HELOC approval process takes 30 to 60 days, though some lenders offer faster timelines. The process includes application, appraisal, underwriting, and closing. Start the process early to ensure funds are available when construction begins.