The Federal Housing Administration (FHA) recently proposed changes to its guidelines that may make it easier for families to build wealth and increase the housing supply through the purchase or construction of accessory dwelling units (ADUs). The proposal aims to allow lenders to offer renovation loans for ADU construction and consider future rental income from the unit when calculating how much a customer can afford to borrow. According to Jon Healey of The LA Times, this change will address one of the significant barriers for people with low to moderate incomes and little home equity when trying to secure a loan for ADU construction.
The proposed changes include allowing FHA-backed construction loans to be used for building both a house and an ADU, which would enable more people to own homes that include income-generating property, like duplexes, while also increasing the housing supply. The FHA’s proposed changes are a draft and may change based on public input.
The proposal recognizes the challenge associated with ADUs and the lack of historical data about their value. According to the FHA Commissioner, Julia R. Gordon, “It’s a little bit of a chicken-and-egg problem — there’s not enough data for lenders to figure out how to underwrite the projects, but without the loans, there’s no way to generate more data.” As a result, the FHA has put the policy on the drafting table to gather feedback to fine-tune the proposal.
The ability to include future rents in loan calculations could make a significant difference in increasing borrowers’ income and their ability to borrow enough money to build an ADU. However, this aspect of the proposal is unique, as Fannie Mae and Freddie Mac do not support loans that factor in theoretical rental income from a yet-to-be-built ADU.
ADU construction has taken off in California, accounting for 15% of the housing units approved in the state in 2021. However, this type of project is becoming a national phenomenon as more communities grapple with shortages of affordable housing and the need to increase density. The proposed changes aim to support ADUs the way the FHA has supported the construction and purchase of duplexes, but with additional safeguards.
Healey explains that the proposal would classify a single-family home with an ADU as a one-unit property. The FHA’s rapid online loan evaluations would allow lenders to consider only 50% of the fair market rents a new ADU could generate, while the limit is 75% for duplexes. The rents could constitute no more than 30% of the borrower’s total income when determining the loan amount.
The proposal could make a significant impact in facilitating ADU construction and increasing affordable housing, as more communities nationwide are looking to ADUs as a more palatable first step in making adjustments to zoning. ADUs that can be rented out and appreciate in value over the years also create an opportunity to build wealth from generation to generation.
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