Construction loans release money in stages as your ADU is built – so you only borrow what you need, when you need it. Here's how they work, what they cost, and when they beat a HELOC or cash-out refi.
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An ADU construction loan releases funds in stages – called draws – tied to completed build milestones like foundation, framing, and rough-ins. You pay interest only on the amount drawn during construction, not the full loan total. A construction-to-permanent version converts automatically into a regular long-term mortgage once your ADU passes final inspection, saving you a second closing. Construction loans are the right tool when you don't have enough home equity for a HELOC or cash-out refinance but need project funding up front.
Only about 6.3% of California ADU builders used a renovation or construction loan to finance their project, according to a survey of roughly 800 builders by the Terner Center and CA YIMBY. Most paid cash (~67%) or tapped home equity (~43%). That underutilization matters: if you don't have a pile of cash or a fat equity cushion, a construction loan may be the most overlooked path to building your ADU.
All-in ADU costs in Los Angeles typically run $150,000–$400,000+, with the statewide median around $150,000 per Terner Center research. Knowing your financing options before you meet a builder puts you in a stronger position. Read on for the full picture – then explore all LA ADU financing options once you've got the construction loan basics down.
A standard mortgage hands you a lump sum at closing. A construction loan works differently: the lender holds the approved total and releases portions – called draws – as your builder completes pre-agreed milestones.
Typical draw milestones for an ADU build might look like:
Before each draw, the lender typically sends an inspector to verify the milestone was actually completed. Once confirmed, the draw funds go directly to your contractor (or to you to pay the contractor, depending on the lender's process).
During the construction phase you pay interest only on the amount drawn, not on the full approved loan amount. So if your construction loan is approved for $250,000 but you've only drawn $80,000 through framing, you're paying interest on $80,000. This keeps your monthly carrying cost lower while the build is underway – though it does mean your payment increases with each draw.
The construction phase is typically 6–18 months depending on project scope. Most LA ADU projects targeting a detached unit with standard finishes fall somewhere in the 9–12 month window.
You have two structural choices when taking out an ADU construction loan. Understanding the difference upfront will save you money and headaches at the end of the build.
With a construction-to-permanent loan – sometimes called a one-time-close or C2P loan – you close once at the start of the project. The loan functions as a construction loan during the build, then automatically converts into a standard long-term mortgage (typically 15 or 30 years) when the ADU receives its certificate of occupancy.
A stand-alone construction loan covers the build period only. When construction ends, you must pay off the balance – either with cash, by selling the property, or by refinancing into a separate permanent mortgage (sometimes called an end loan).
For most homeowners financing a single ADU, a construction-to-permanent loan is simpler and lower-risk. The one-time-close structure eliminates the uncertainty of finding end-loan financing mid-project.
Construction loans carry higher interest rates than standard purchase mortgages or cash-out refinances. There are two main reasons: the lender is taking on more risk (an ADU under construction has no finished collateral), and the draw-schedule structure requires more active loan management.
Rates move with broader market conditions, so we won't promise a specific number here – always verify current pricing directly with a lender. For context, the broader ADU financing menu in mid-2026 looks roughly like:
| Option | Typical rate range | Notes |
|---|---|---|
| Construction loan | Higher than standard mortgage | Verify with lender; construction phase interest-only |
| HELOC | ~7–9% | Variable; requires existing equity |
| Cash-out refinance | ~6–8% | Replaces primary mortgage; requires equity |
| ADU-specific & renovation loans | ~6–8% | Based on as-completed value; lower-equity option |
The construction loan's rate premium is the trade-off for getting project funding without needing existing equity – and that premium applies primarily during the build phase. Once a C2P loan converts to permanent, the ongoing rate is typically in line with the conventional mortgage market at that time.
Beyond the interest rate, budget for: origination fees (typically 1–2% of the loan), appraisal costs, draw inspection fees (often $100–200 per inspection), title insurance, and closing costs. These add up, especially on a construction-to-perm that converts at the end.
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See if you qualify – free Request a Free IntroConstruction loan underwriting looks at two things simultaneously: you (income, credit, existing debt) and the project (plans, contractor, fixed-price contract). Both have to check out.
Many homeowners assume they can count future ADU rental income toward their qualifying income. In practice, Fannie Mae and Freddie Mac guidelines generally do not allow projected ADU rental income to count toward qualifying (source: JVM Lending). You need to qualify on your own documented income. This is one of the harder constraints for borrowers in high-cost LA markets – confirm the specific rules with your lender, as portfolio lenders and some programs handle this differently.
No single financing tool wins for everyone. Here's how to think about which one fits your situation. See also our full guide on HELOC vs cash-out refi for ADUs and our page on financing an ADU with little or no equity.
| Option | Best when… | Typical rate |
|---|---|---|
| Construction loan | You don't have enough equity for a HELOC or refi, but you have a licensed builder and approved plans ready | Higher than standard mortgage; verify with lender |
| HELOC | You have solid existing equity, want a revolving line of credit, and can tolerate variable rates | ~7–9% variable |
| Cash-out refinance | You have equity AND your current mortgage rate is already high enough that replacing it doesn't hurt much | ~6–8% |
| ARV / renovation loan | Low current equity but strong as-completed value; want to borrow up to ~90% of ARV or up to ~$750K | ~6–8%; see RenoFi ADU programs |
The clearest case for a construction loan: you want to build now but don't have the equity to support a HELOC or cash-out refi, and you're not sitting on enough cash to self-fund. The staged draws mean you're never borrowing a lump sum you don't yet need, which keeps interest costs in check during the build.
The clearest case for a HELOC or cash-out refi: you already have significant equity in your home and want a simpler, lower-rate borrowing structure without milestone inspections and draw logistics. See our full LA ADU financing guide for a deeper side-by-side.
If you're low on equity and the project's as-completed value is strong, an ARV or renovation loan (sometimes called a RenoFi-type loan) can bridge the gap – these programs lend based on what the property will be worth after the ADU is complete, not just current equity.
A regular mortgage delivers a lump sum at closing based on the current appraised value of a finished property. A construction loan releases funds in stages – called draws – tied to completed build milestones, and you pay interest only on the amount drawn. It's designed for projects that don't yet exist as finished collateral. Once construction is complete, a construction-to-permanent loan converts to a standard long-term mortgage automatically.
Generally no – Fannie Mae and Freddie Mac guidelines typically do not allow projected ADU rental income to count toward qualifying income. You need to qualify based on your own documented income and debt-to-income ratio. Some portfolio lenders and specific loan programs handle this differently, so it's worth asking your lender directly about their policy.
Most ADU construction loans have 4–6 draws tied to verifiable milestones: permits and site prep, foundation, framing, rough mechanical and electrical, finishes, and final completion with a certificate of occupancy. Before each draw the lender typically sends an inspector to confirm the milestone is actually done. The exact draw schedule is agreed upon at loan origination and specified in your loan documents.
Yes. Virtually every construction lender requires your builder to hold a current, valid CSLB (Contractors State License Board) license and carry liability and workers' compensation insurance. Owner-builder arrangements are sometimes allowed but face much stricter scrutiny, and many lenders won't do them at all for residential ADU projects. Confirming your builder's license status before you apply saves time.
For most homeowners building a single ADU, a construction-to-permanent (one-time-close) loan is simpler and lower-risk. You close once, pay one set of closing costs, and the loan converts automatically to a long-term mortgage at completion – no need to re-qualify or find a new lender mid-project. A stand-alone construction loan gives more flexibility on the permanent mortgage (useful if you expect rates to fall), but it requires two closings, two sets of costs, and exposes you to re-qualification risk when construction ends.
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