Financing an Accessory Dwelling Unit: A Matter of Trust
March 11, 2020
“My wife and I are seniors, our house is worth about $1 million with a loan balance of $460,000. The payment on the loan is quite burdensome, and we have been offered the following deal by my daughter’s fiancée. He would pay off our loan after which we would transfer ownership to him. He would then build an accessory dwelling unit (ADU) on the lot that we could live in rent-free. What do you think?”
My first thought was that if you preferred to stay
in your current house, your better option would be a reverse
mortgage which would eliminate the required payment on your
existing mortgage. While the loan balance on a reverse
mortgage would be slightly higher, the reverse mortgage
would have no required monthly payment.
Unfortunately, I found that at your ages, your loan
balance is a little too high to qualify. My estimate is that
you would probably qualify in 2 years because your loan
balance will be a little lower at that time, and you will be
2 years older. But you may not want to wait, so let me turn
to the option you have been offered.
It would be
useful to look at it from the perspective of your daughter’s
fiancée. He acquires a house worth $1 million for $460,000.
him $540,000 ahead. In exchange, he has an obligation to
build an ADU for you that you will occupy rent-free. Since
he receives no revenue from it for an indefinite period, he
has a financial incentive to minimize the cost and extend
the process. If he behaves like an “economic man”, the ADU
could take a long time to build, and may not meet your needs
when it does.
This might not happen, of course, he might be a great guy, family-oriented and generous. The key point is that you have to trust him, and the fact that he is not yet in your family is not helpful.
But there is another way to do
it that does not require you to trust someone who is not yet
part of the family. This would involve having the ADU built
first, with the transfer of ownership of your existing house
not occurring until after the ADU has been completed to your
satisfaction. This flips the power to abuse from him to you.
He has to trust you not to make unreasonable demands that
raise the cost of building the ADU and delay the transfer of
Doing it this way has the
disadvantage for you that you don’t get out from under the
burdensome mortgage payment until the deal is done and the
mortgage is paid off. But this gives you an incentive to get
the deal done quickly. Doing it his way provides an
incentive for him to drag out the process because he gets
your home equity upfront. Bottom line, he has a much better
reason to trust you than you have to trust him.
Do it your way.