Adding an ADU to your property increases its value and makes it more desirable for a range of buyers in San Jose. However, adding value and adding equity are not quite the same thing. While paying value off adds equity over time, constructing an ADU may not actually add equity, depending on your circumstances. Here is what you need to know about how an ADU may impact your equity.
Increasing Home Values Adds Equity
In general, when you make improvements to your home which increase its value, you raise your equity as well. If, before your renovations, you have a home worth $600,000, and you’ve paid off $500,000 of the mortgage, then you owe $100,000. That’s the equity of the home, the amount the house is worth, subtracted by the amount owing on your mortgage: $500,000.
When you add an ADU, the amount that the ADU is worth increases your home value but does not increase your mortgage amount. For example, you add a ADU to your home and it increases the home’s value by $100,000. Your home is now worth $700,000, but you still only have $100,000 owing on your mortgage. Your total equity is now $600,000.
If you sold your home, you’d receive the price you sold the home for minus what you still owe on the mortgage. You need to sell your home, refinance it, or get some other equity-accessing financial product to realize this equity gain.
Consider Your Funding Source
There are many different tools homeowners use to build ADUs, but one of the most popular options is to tap into one’s home equity. There are many ways to do this, including:
- HELOC: A home equity line of credit is a line of credit where you take money out of your home equity. The terms for these vary widely.
- Refinancing: You can refinance your home to get access to the equity that you currently have in it. Doing so can significantly increase your mortgage payments.
When you finance your ADU using your equity, it may not necessarily increase your equity. Instead, you’ll need to do some math to determine what might happen. How much has your financing method reduced your equity, and has the value of your home gone up more than that? That is the only way that your ADU will add equity in this case. If you end up spending more on your HELOC or refinance than your ADU adds to your property value, adding one may reduce your equity.
On the other hand, your ADU does increase the value of your home, and as you pay off your financing and your mortgage, your equity will increase.
How Much Equity Can I Add with an ADU?
It’s not perfectly predictable. The amount of value your ADU adds to your home depends on many factors, including its size and quality, the existing value of your home, the needs of your potential buyers, and the characteristics of your neighbourhood. An ADU in San Jose may increase your home value by 25-30%.