ADU loan program has $100,000 for OC homeowners who rent to low-income tenants

Borrowers must rent to the poor for the first 10 years.

By JEFF LAZERSON | jlazerson@mortgagegrader.com | MortgageGrader.com | October 30, 2023

Article originally posted in Orange County Register on October 27, 2023.

On Oct. 14, Gov. Gavin Newsom signed Assembly Bill 1033, paving the path for accessory dwelling units to be sold separately from the primary residence, creating two-unit condos.

This week, I’ll dive into how homeowners can finance the construction of an ADU.

While there are myriad ways to finance such construction, at the top of my list is the Orange County Housing Finance Trust. The nonprofit’s program — which came online Oct. 24 and is only for Orange County homeowners — finances construction loans for up to $100,000. And there are no monthly payments. Homeowners won’t need to make any interim payments, either. What borrowers will face is a balloon payment 20 years later.

So, what’s the catch? Owners must rent the ADU to very low-income tenants for the first 10 years.

The trust also says that if you follow the rules (renters’ income must be less than 50% of the area median income), you could see almost half, or 48%, of your debt forgiven, assuming a $100,000 original loan.

There is no formal mortgage qualifying required either.

“There is no income evaluation,” said Amanda Grill, compliance manager at Orange County Housing Trust.

The trust was founded in 2019 between participating cities and the county. Its purpose is to support the homeless population and those who are living with extremely low incomes. Non-participating cities include Brea, Cypress, La Palma, Laguna Woods, Los Alamitos, Rancho Santa Margarita, San Clemente and Villa Park.

“We’re a government bank,” said Adam Eliason, trust manager at OC HFT. “We’re not here to advise on loan qualifying. We don’t want the liability. We approve applications for funding.”

The accruing interest rate on the construction financing is zero to 3%. For any period in the first 10 years in which the tenant falls outside the very low-income parameters, the borrower’s accruing interest rate will be higher. For example: a tenant with a Section 8 housing voucher means the borrower’s interest rate would be zero. If the tenant is within the low-income limits but without a voucher, the interest rate rises to 3%.

Homeowners must submit lease information to the trust. Annual audits are performed by HFT to validate the information.

Examples from the trust’s lending brochure offer tenant examples including a parent, child, new neighbor, an old friend, or a voucher-holder.

In a nutshell, if you want this nearly free money offered by the trust, it’s best to rent to a very low-income tenant. And owners must occupy the primary home to qualify.

More information and financing programs for Southern California homeowners can be found at housingsocal.org, according to Eliason.

It’s worth noting that an ADU from the ground up will likely cost a homeowner much more than $100,000. That means more complex financing for most homeowners.

ADU construction costs range broadly from $350 to $400 per square foot, according to Mark Lefitz, vice president of business development at EZ Plans. And those costs depend on whether the new construction is attached or detached from the primary residence, garage conversion, lot flatness or not, etc.

A 1,000-square-foot ADU at $400 per square foot might cost $400,000. Homeowners will likely need to string together several financing sources. Savings, borrowing from a retirement account or a securities account, home equity lines-of-credit or perhaps the bank of mom and dad.

There are other ADU institutional construction financing programs available but they come with subsidized money like the Orange County Housing Trust For example, there’s the FHA 203(k), Fannie Mae Homestyle, Freddie Mac Choice Renovation and USDA Renovation, all of which have some financing available for ADUs.

And what about VA loans?

“Due to the unique nature and complexity of the bill (AB 1033), it will take some time for the Loan Guaranty Service to analyze the impacts from policy and legal prospectives,” said VA press secretary Terrence Hayes (in part) via email. “VA is working diligently to address this matter.”

Excluding the no-income qualifying Orange County Housing Trust program, if you struggle to qualify for ADU/condo construction financing, private money might be the road to go.

Sandy MacDougall, CEO and founder of Mortgage Vintage, points out that homeowners can much more easily qualify to build an ADU using hard money loans because it’s an owner-occupied business purpose loan.

The combined loan to value or CLTV caps out at 65% on a second lien, according to MacDougall. For example, a homeowner’s first mortgage balance is $500,000 and they are securing a private second loan for $250,000. Your home is worth $1.2 million. So, the $750,000 loan total divided by $1.2 million value equates to 62.5% CLTV. That math works.

“We do ask for a couple of months of bank statements only to analyze the borrower’s ability to repay,” said MacDougall. “We are less FICO sensitive.”

Terms are 12-24 months with 2 points cost plus a $1,995 underwriting fee (each 1 point is 1% of the loan amount). The second mortgage rate is 12% to 14.5% depending on credit and CLTV, MacDougall said.

Let’s say the construction is completed and now you want to do the condo conversion.

Very briefly stated and overly simplified, you will need to go to your city’s building department to get a detailed list of what it requires to create the condo association and the legal condo unit entities. I’d sanity-check everything through a sharp real estate lawyer.

If you have mortgage liens, you may find yourself in an untenable situation of trying to clear the mortgage liens and change the legal vesting requirements. In other words, the original mortgage encumbers all of the land and all of the dwelling(s) built on it. When a homeowner splits up a property (say, for a two-unit condo) they cannot split up the loan. The lienholder could foreclose on the borrower for violating the note terms. Therefore, owners have to get separate financing.

The good news is Fannie and Freddie allow two-unit condo financing. So, you could get your legal documents in order with the city. Consider paying off any existing mortgages with two separate first liens on the two units.

No matter what else, find a knowledgeable mortgage professional to advise you.

My next column will dig into California’s lot-splitting laws which are required to separately sell your ADU and its lot.

Freddie Mac rate news: The 30-year fixed rate averaged 7.79%, 16 basis points higher than last week. The 15-year fixed rate averaged 7.03%, 11 basis points higher than last week.

The Mortgage Bankers Association reported a 1% mortgage application decrease compared to last week.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $726,200 loan, last year’s payment was $352 less than this week’s payment of $5,223.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 7.125%, a 15-year conventional at 7%, a 30-year conventional at 7.5%, a 15-year conventional high balance at 7.875% ($726,201 to $1,089,300), a 30-year high balance conventional at 7.875% and a jumbo 30-year fixed at 7.75%.

Note: The 30-year FHA conforming loan is limited to loans of $644,000 in the Inland Empire and $726,200 in LA and Orange counties.

Eye catcher loan program of the week: A 30-year adjustable, interest-only and fixed for the first five years, rate at 7.75% with 1 point cost.

Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or jlazerson@mortgagegrader.com. His website is www.mortgagegrader.com.

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* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.