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MortgagePoint ยป Your Trusted Source for Mortgage Banking and Servicing News 32 March 2025 F E A T U R E S T O R Y the size of the structure is smaller and requires less material. The smaller size also often means lower energy costs, and, if the ADU is newly built, it can also feature energy saving appliances to bring the operational cost down even further. With this, you can have your relatives close by at a lower cost, but still keep them at enough of a distance to function independently with your own space. Instead of spending money to rent an apartment or buy a house, people are converting spaces in or around their home to ADUs for added space and to save money and avoid construction costs. A popular use for ADUs in the current market is also to rent out the space to earn additional income. This can be beneficial in several ways, includ- ing that the borrower, in some cases, can use the rental income to qualify for loans or specific programs. For lenders, ADUs should be seen as an added opportunity for business in a volatile market. The GSEs are even taking notice of the trend and expand- ing policies for broader mortgage possibilities, with programs like Freddie Mac's CHOICERenovation Mortgages and Fannie Mae's HomeStyle Reno- vation program. For lenders, this also comes with the opportunity to educate borrowers. According to a 2023 survey by Freddie Mac, 71% of respondents were unfamiliar with ADUs. But, once they learned more about them, 32% of those who currently do not have an ADU on their property said they were interested in the prospect. During a difficult mar- ket, ADUs can provide a new space for lenders to enter that will benefit them financially. Challenges and Obstacles W hile ADUs serve a purpose with today's tight housing inventory, they also come with numerous caveats, and there are things that both borrow- ers and lenders need to stay on top of. Regulations surrounding ADUs are ever-changing and with this rapid evolu- tion, it is important to stay up to date on all local and state zoning laws, building codes and permit regulations. These differ not only by state, but by individ- ual municipality. Restrictions can range from size requirements to height and setback rules. Not following local zoning regulations can lead to fines, penalties, and even possible legal action. All of this could delay the project and end up costing the borrower money. Having a qualified contractor with experience in ADU construction who knows and understands the local regulations is vital to success. Borrowers also need to be aware of occupancy requirements and regula- tions around renting, along with rental rates and laws that prohibit short-term rentals. Restrictions can range from requiring only family members to live in an ADU to prohibiting leases from be- ing less than 30 days. Some regulations that we have seen even specify nuanced requirements, including prohibiting a storage shed from being turned into an ADU. Some municipalities also require ADUs to be registered and include an annual fee. HOAs even often have their own requirements for ADUs that need to be followed. So, there is a lot to pay attention to. For ADUs that are legal noncon- forming or illegally built, there are many hurdles to overcome. In very extreme cases, the property owner could be required to tear down the structure. This does not happen often, but it is something property owners and build- ers alike should be mindful of. Rental income from an illegal ADU also cannot be used to qualify the borrower for a loan. For lenders, unnecessary delays due to material defects could end up jeopardizing their relationship with the borrower. Choosing the Right Appraiser Matters W orking with the right appraiser who has experience with ADUs and their complexities also is key. There are additional rules that appraisers must follow for ADUs and appraisers with knowledge in this space often are in high demand. For appraisers, it is important to remember that as a part of their certification they must state that they are knowledgeable and experi- enced in the niche market they are appraising. This is a requirement that follows through the entire process. The appraiser also must have a knowledge of comparable sales require- ments. Automated Valuation Models (AVMs) are less reliable for ADUs and waivers generally are not accepted. Realtors and Multiple Listing Services (MLSs) are not consistent with their reporting of ADUs and this can create added challenge for the appraiser. Ap- praisers also must take extra steps when rental income generated from the ADU is used to qualify the borrower. Clear communication with the appraiser is key to avoid unnecessary delays. What Lies Ahead? A DUs likely will continue to grow in popularity over the next several years. With the national housing short- age, coupled with higher-than-average interest rates, and increasing home costs, there is a market for outside- the-box solutions, including ADUs and manufactured housing. Property owners do not even need to construct a new structure on their property and instead can turn existing basements, garages, and backyard structures into an ADU. ADUs continue to provide more affordable housing and opportunities for multigenerational living and that will help their popularity to continue to rise.