How to Finance SB 9 Projects
Senate Bill 9 gives California homeowners the legal right to build additional residential units on their property. However, the law doesn’t provide them with a clear path for financing these projects. Because SB 9 is such new and unprecedented legislation, financial institutions have yet to establish standard practices for financing the kinds of small-scale, homeowner-led housing developments that the new law will usher in.
In the following guide, we'll explore the financing options that currently exist for funding SB 9 projects and help you understand which type of financing is best for you.
SB 9 Financing Options
Currently, there are three main avenues for funding an SB 9 project: cash-out refinancing, construction loans, and partnering with Homestead.
A cash-out refinance is a type of mortgage refinance that allows a homeowner to exchange some of the equity they've built up in their home for a cash payment in the form of a lump sum, which can be used to fund SB 9 projects.
How it works
Unlike taking out a second mortgage, which adds an additional monthly payment, a cash-out refinance replaces your old mortgage with a new one. This feature is attractive for many qualifying homeowners who prefer the convenience of a single monthly payment.
- Lower interest rates (compared to those for other borrowing options, e.g. credit cards, construction loans, etc)
- High borrowing power allows homeowner to borrow up to 80% of their home’s current value
- Consolidation of mortgage and construction financing into a single loan
- Lump sum payment makes funds available immediately
- Accessible funds might not be sufficient. Building a new home or duplex can cost hundreds of thousands of dollars, and many homeowners do not have enough equity built up to fully cover the costs of their project.
- Must have a low DTI (Debt-To-Income) ratio. Cash-out refinancing necessitates that your total debt payments (credit cards, student loans, car payments, etc.) are less than 45%-50% of your gross income. In an expensive state like California, this is difficult for most homeowners to achieve.
In short, cash-out refinancing can be a good option for homeowners who have a lot of equity built up in their home and want to consolidate their monthly payments. But if you haven’t built up much equity yet or your monthly debt-to-income ratio is too high, a cash-out refinance might not work for you.
Construction loans are short-term loans specifically for new construction or home improvement projects–including building an additional dwelling unit on one’s property.
How it works
While traditional refi loans are determined by the current value of one’s home, construction loans are distinctive because they allow homeowners to borrow against the projected value of their home once renovations are complete. This makes the construction loan an attractive option for recent home buyers and others who have yet to build much equity.
Construction loans also come with their share of drawbacks which one must take into consideration. These loans are subject to tighter regulations and require extra bank oversight when compared to other financing options.
For example, the bank must approve the contractor you've hired before they'll approve your loan. The bank also wants to see surveys, lot subdivision maps, city approvals, blueprints, building permits, and contracts for all estimates in the building process before approval. That’s a lot of expensive legwork to undertake before the financing is even secured!
Furthermore, many contractors are hesitant to work with homeowners who use these loans because they require extra oversight from the bank and money is only released at certain construction milestones. In order to take out a construction loan, you have to have the ability to either fully repay or refinance the loan within two years, which can be limiting. In addition to the aforementioned obstacles, construction loans carry higher closing costs than refi loans and require low DTIs and high credit scores in order to qualify.
- Higher borrowing power than traditional refi loans
- Not dependent upon established equity
- Higher closing costs and interest rates than refi loans
- Must have low DTI (<43%) and high credit (700+) to qualify
- Project must be completed within projected timeline
- Must repay or refinance within a fixed period (usually 2 years or less)
- Multiple hoops to jump through prior to bank approval
- Cash isn’t accessible all at once, as funds are portioned out and released only at certain points in the construction process
- Extra oversight and restrictions make some contractors reluctant to sign on
Construction loans are only advisable for homeowners with low home equity, as higher closing costs and increased oversight and limitations are definite drawbacks. And if your debt-to-income ratio is too high or your credit score too low, you might not qualify.
Construction Loan Hack: CalHFA ADU Grant Program
If part of your SB 9 plans include an ADU construction and you’re interested in pursuing a construction loan, you might want to consider the California Housing Finance Agency’s grant program. Qualifying homeowners can receive a grant of up to $25,000 to help pay for predevelopment costs associated with ADU construction. While it certainly won’t cover the cost of construction, it will help to lower it. Learn more about the grant program and other ways to pay for an accessory dwelling unit in our guide How to Finance an ADU or Garage Conversion.
Partner with Homestead
If the above lending options don’t work for you and you don’t have cash on hand (or you don’t want to take on more debt), consider partnering with Homestead. Homestead helps you split your lot and our team of MIT-trained architects design and build a new house on the second lot. We secure all financing, so you don’t pay for anything upfront. When the project is complete, you can either pay us for the completed home and get a traditional mortgage for it, or let us sell it.
How it works
If you want to keep the new house, you end up with a brand new property for half the price of buying it on the market, without spending any money during the building process. And if you let us sell the new home, you keep 80% of the net profit—upwards of $300k! In more competitive markets (like parts of the Bay Area, Los Angeles, and San Diego), you stand to make as much as $1M or more from the sale.
Our units rent for 30% above average, and we project them to sell well above the going market values. You’re almost certain to reap higher profits from your SB 9 lot split project when you work with Homestead than you would on your own, and with no risk or money upfront.
- No money down
- No monthly payments — you never take out a loan or pay monthly payments
- Not dependent on your credit score or DTI
- No risk of losing home or default
- Get all the rewards ($300k+ profit) right when the project is completed
- Not right for people with $500k+ cash for the project.
- If you want to retain ownership of the new property you have to buy it back. However, it will be easy to get a loan to buy it back because
you'll be getting a fully finished rental property well below market price.
Partnering with Homestead is a great option for homeowners on any kind of budget, regardless of their credit, DTI, or amount of home equity accrued. Because Homestead assumes all the risk and fronts all the money, you don’t have to navigate the confusing world of loans and refinancing options. Furthermore, there is no risk of losing your house due to Homestead's participation.
SB 9 is still very new, and it remains to be seen how different cities and municipalities will interpret and implement the law. As time goes on, it's quite possible that additional financing options will emerge and allow homeowners even more possibilities for financing their projects. For now, your best bets are cash-out refinancing, construction loans, and Homestead. With Homestead and SB 9, we can all do our part to help end the housing crisis and make California livable and enjoyable for all its residents.
If you're interested in partnering with Homestead, contact us today for a free evaluation of your property or use our search tool to determine whether it's eligible for further development under SB 9.