Yahoo Finance Homebuyers and owners get a lending boost from potential rental units on their properties
In-law suites, garage apartments, and tiny homes in the backyard can make it easier for homebuyers and owners to borrow money now.
Lenders can count 75% of estimated rental income from accessory dwelling units, or ADUs, as qualifying income when underwriting a mortgage backed by the Federal Housing Administration, the US Department of Housing and Urban Development announced this week. The new provision also allows 50% of the estimated rental income for a to-be-built ADU to qualify for a mortgage under the FHA’s renovation home loan.
Read more: How to get a mortgage in 2023
The FHA defines an ADU as a unit that has a separate entrance and meets all requirements for habitation. An ADU can be in addition to, part of, or detached from the primary residence.
The aim of the new rules is to help ease the national housing shortage crisis by creating more supply through private owners. It also seeks to help new buyers and existing homeowners create more housing equity by providing financing for ADUs.
"With our new ADU policy, we’ll help households of more modest means maximize the potential benefits of homeownership to build wealth," Julia Gordon, assistant secretary for housing, said in a statement. "This new policy also contributes to the supply of affordable housing in many neighborhoods where it’s most needed and least available."
Could ADU ease the housing shortage?
The US currently needs 6.5 million more housing units to accommodate its growing households, according to Realtor.com. The gap occurred in the last decade when 15.6 million households were formed but only 9.03 million new single-family homes were developed. That gap shrinks to 2.3 million if counting multi-family developments developed during the period, but still remains large.
As a result of the shortage, the rental vacancy rate dropped to its lowest level since 2000 to 5.6% in fourth quarter of 2021 and again in the second quarter of 2022, according to Realtor.com. Rents also have been rising. The national median rent jumped by 22% in five years between 2016 and 2021.
"For many Americans, an affordable home is harder than ever to come by," Emily Hamilton, senior research fellow at Mercatus Center at the George Mason University, wrote in an opinion column. "ADUs — small rental units that can be added to existing properties and ease housing shortages — are at the forefront of these efforts. From an affordability perspective, ADUs are an attractive reform option because these units can rent for hundreds of dollars less than apartments in the same neighborhood."
ADUs are on the rise. Nearly 1.4 million units throughout the nation were identified by Freddie Mac in 2019. The number of ADUs in the US also grew on an average of 8.6% year over year from 2009 to 2019, according to the data.
The share of ADUs available in active listings also grew to 6.8% in 2019 from 1.6% in 2000, the data found. The gain is also reflected in homes sold; nearly 70,000 sold homes came with ADU in 2019, about 6.7 times more than 2000, the data shows.
The majority of ADUs in the nation are located in areas that are experiencing major rent growth. For instance, California, Florida, Texas, and Georgia account for half of the 1.4 million ADUs identified by Freddie Mac, and three of those states — California, Florida, and Texas — all saw their median rents rise faster than the national average in the last two years, according to tracking by iPropertyManagement.
"These desirable areas have all been losing residents in recent years—in large part due to the lack of affordable housing options," Scott Wild, senior vice president of consulting at John Burns, a US housing research and consulting firm, wrote about California and the rise of ADUs. "Land is in short supply, and building new neighborhoods is a long and challenging process."
Financing an ADU
Lenders always review an applicant's debt-to-income, or DTI, ratio to determine the individual's risk and ability to pay back a loan when underwriting a mortgage.
The new rule that lets mortgage underwriters include estimated ADU rental income lowers a borrower's DTI ratio by increasing the income portion of the equation, giving them a stronger borrowing stance.
The extra income qualifier can significantly help owners finance for ADUs as units around 600 square feet bring in between $1,600 to $2,500 monthly rents in major cities, according to Maxable, which offers guides for homeowners on planning, hiring, and managing an ADU.
"The income component is going to help with qualifying," Jason Mata, a mortgage professional with American Pacific Mortgage, told Yahoo Finance. "It's going to give them more capacity to be able to borrow."
That's especially helpful now with mortgage rates rising toward 8% and borrowers are facing affordability challenges.
Read more: Mortgage rates at 20-year high: Is 2023 a good time to buy a house?
"New buyers that are ready to endure these rates, these changes could help them get a little bit more buying capacity," Mata said. "They are just trying to create affordability."
Rebecca Chen is a reporter for Yahoo Finance and previously worked as an investment tax certified public accountant (CPA).
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