Over half of U.S. mortgages are backed by either Freddie Mac or Fannie Mae. Having one of these finance companies change their rules about additional dwelling units is a huge deal for everyone. So, what are the changes Freddie Mac made to their policies that will help buyers and sellers who deal with properties containing ADUs?
Freddie Mac’s new regulation allows for the use of rental income for qualifying borrowers with 1-unit primary residences. However, there are stipulations to this change in policy.
Allowing for future ADU rental income to be included in the decision on how much an individual can borrow for a home increases their buying power. This change in Freddie Mac regulations can help open the door to making housing affordable again. Read on to find out the requirements and qualifications associated with the new regulation.
What Is Freddie Mac?
Before we dive into the latest changes, let us first define what Freddie Mac is for those of you who may not know. Freddie Mac, also known as the Federal Home Loan Mortgage Corporation, or FHLMC, is a secondary market financing company. It was chartered by Congress in 1970 as part of the Emergency Home Finance Act to expand the secondary mortgage market in the United States.
The goal of Freddie Mac is to keep money flowing to mortgage lenders to support homeownership and rental housing.
Previous Freddie Mac Regulations
To help you understand how big these changes are, we will first explain what the previous Freddie Mac regulations entailed.
Before these new regulations, Freddie Mac allowed an ADU only on a 1-unit property. Rental income generated from an ADU was not permitted for consideration towards a loan, except for in the case of Home Possible mortgages or when the rental income was paid by a living aid residing with the borrower.
Basically, the chances of your rental income counting towards your mortgage loan were not very high. Also, you could only have an ADU on a single-family residence.
What’s Changed with Freddie Mac
Two main aspects of Freddie Mac policies changed with the recent updates.
The first is that they are now allowing ADUs on mortgages secured by additional property types besides single-family residences. The policy update now allows for the development of one ADU on 2–3-unit properties. However, the total number of units cannot exceed 4.
The second update, and the main topic we would like to focus on, is that they have expanded the use of rental income for qualifying borrowers who have 1-unit primary residences. In other words, income from a rented ADU can now be used to qualify for a loan in an amount up to 30% of the total income used to qualify.
The new policies provide even more options for adding an ADU to a home. They also make it easier to finance a purchase where you intend to rent or build an ADU on the property by allowing the borrower to use rental income to qualify.
To take advantage of the higher buying power opportunity, you first need to be aware of the stipulations associated with using rental income towards your qualifying income.
ADU Must Be Legal
The very first thing you should know about the new regulation is that it applies only to legal ADUs.
If the homeowner decided to build an ADU but did not acquire the correct permits, their unit is considered illegal and therefore won’t count towards the new regulations. Some states have a very relaxed permitting processes, so you will need to check with your local government to determine what you need to do to make your unit legal.
In all states though, an ADU must include the following to be considered a legal ADU.
- Be smaller than the primary residence (ADU size limits)
- Have a bathing area
- Have a kitchen with cabinets, a countertop, a sink, and a stove hookup
- Have a means of ingress/egress
- Have a sleeping area
- Have bathroom facilities
You can always legalize an unpermitted ADU to make it count towards the new regulations. Many local governments have unit legalization programs that make this process much easier. Talk with an ADU professional to determine what you need to do to bring your ADU up to code.
Freddie Mac ADU Requirements
For your ADU to count towards the new policy, Freddie Mac has supplied a list of requirements it must meet.
- ADUs that are manufactured homes are only allowed under certain conditions
- The ADU must comply with local ADU zoning laws and land use requirements
- There can be only one ADU on a 1-, 2- and 3-unit property
You will need to check with a trusted lender to learn more about what ADU manufactured homes count.
As for zoning laws, the zoning compliance must be either legal, legal non-conforming, or locations with no zoning. There are, however, certain conditions in which an ADU on a 1-unit property may have illegal zoning. This often occurs when the ADU was built before the current zoning laws were created, so it gets grandfathered in.
You can talk with a reputable lender about what qualifies as an ADU in the area you live in. You can also look at Freddie Mac Guidelines, but these can be hard to wrap your head around. So, it is probably best to just speak with a reputable lender about your specific situation.
ADU Appraisal Requirements
An appraiser will come and inspect the property. They will do things like inspect the house, pull tax rolls, take pictures, and pull permits. An important note here is that even if an appraiser says it is an ADU, if it is not properly permitted, it will not qualify. You need the proper permits whether your ADU is up to code and meets all the regulations or not. Rental income from an illegal ADU cannot be used to qualify.
An appraiser will create a rental analysis that is required to support the area’s marketability of rented ADUs and the ADU’s market rent when rental income is used to qualify. As part of this analysis, they must provide “at least one comparable sale with an ADU that is rented, and at least one comparable rental ADU.”
The appraiser must also describe the ADU in a way that includes the general condition of the unit, its square footage of the finished area, and the total number of rooms (including bedrooms and bathrooms).
If an automated collateral evaluation (ACE) appraisal waiver is offered by Loan Product Advisor®, it cannot be accepted. An appraisal report is required no matter what.
Rental Income Requirements
There are two main rules about rental income from the ADU that you need to know about.
The first is that qualifying rental income must not exceed 30% of the total income used to qualify. In other words, you still need to have a good chunk of income coming from other sources besides future rental income to qualify.
The other rule is that rental income that is documented with a lease cannot exceed 75% of the lease amount.
If you want to know more about rental income requirements for an investment property, you can refer to Guide Section 5306.4 of Freddie Mac. If you want to know more about a Home Possible® Mortgage, refer to Guide Section 4501 of Freddie Mac. You can also talk to a trusted lender or ADU professional.
Additional Info About Rental Income Policies
Any borrower who is building or renovating or who has previously built or renovated has the option to use Freddie Mac’s choice renovation offering to finance their ADU. Freddie Mac’s new policies offer ADU flexibility on any Freddie Mac mortgage, not just the affordable offerings. This gives you more choices in the purchase and renovation financing process.
The financing of ADU additions will open another business channel as we begin to see refinancing starting to slow. There is a strong market demand for the purchase or renovation of properties with ADUs that can now be met by offering borrowers more financing options.
We must also note that “at least one qualifying borrower must participate in landlord education for purchase transactions unless the borrower has a minimum of one year of investment property management experience or ADU rental management experience.”
If you want to know more about the new rental income policies, we recommend talking with a trusted lender or an ADU professional in your area.
Buying an ADU With Rental Power
The updated regulations to Freddie Mac allow more buying power to individuals if the house has a potential rental unit and that unit is legal. You can now use the potential future income from renting out the ADU to qualify for more money in your loan. This makes it possible to buy more expensive properties you would otherwise not be able to afford.
Giving buyers more power over what they can afford can help to combat the growing housing problem. It also allows them access to passive income in the future from renting out their units to help pay for their mortgages and property maintenance to help sustain homeownership.
Selling An ADU With Rental Power
Building an ADU yourself on your property can increase your property value. Most people build a unit and rent it out to cover the ADU costs, and then have their realtors list the single-family residence much higher since there is an ADU on the property.
Realtors can list the property at a higher price and still have faith in the fact that it will get sold since buyers now have more power when it comes to qualifying for loans. In the current housing bubble, prices are too high for most buyers, causing some realtors to reconsider their high prices if they are looking to quickly sell. The new regulations can help realtors keep their increased property value prices where the homeowners want and still sell the property in a timely manner.
Essentially, Freddie Mac has made it easier to buy and sell homes with legal ADUs on them which is helping to combat the current housing crisis.
Why Should You Rent An ADU?
Besides using the rental income to qualify for a higher loan, why else should you rent out your ADU?
For starters, you can use the money you acquire from renting the unit out long-term to contribute to property upkeep and to pay off your mortgage. You can even use the unit to house hack if you want.
The other main benefit of renting your ADU is that it provides affordable housing for low-income individuals. You should build an ADU and rent it out to help combat the growing housing crisis plaguing many states. Overly expensive housing cooped with high inflation is leaving many people homeless. By offering an affordable place to live, you could be helping to keep a family off the streets.
You can even rent your ADU to your aging parents, struggling family members/friends, or your young adult kids to help them financially. Many individuals rent their units to their aging parents to keep them close in case they need assistance but within their own personal space. Instead of having to move them in directly with you, you can care for your parents while providing them and your family; the independence and privacy you all desire.
Benefits Of an ADU In General
After you have rented out your ADU unit to pay off your mortgage, you can use it for whatever you may like. There are many ways to use an ADU. It does not have to be a living space. In fact, many people use ADUs as:
- Art studios
- Home offices
- Man caves
- Personal gyms
- Pool houses
- She-sheds
- Yoga studios
If you want to continue to use it as a living space, it can also be great for lodging caretakers, acting as a guest house for visitors, and as a place for you to live once you age. Many homeowners will rent out their ADU until they get to a specific age and then move into the unit for the rest of their lives. They make the unit accessible for older individuals and either rent out their main home or have their children move into their main home. This helps ensure they don’t have to move into assisted living or directly in with their kids.
So, you may want to consider buying a property with an ADU on it to rent out for some time and then use it in other ways once your mortgage is paid off.
Build An ADU Today
If you are looking into building an ADU on your property or future property, let us help! Here at Levi Design Build, our team of experts is committed to providing you with the highest service and craftsmanship throughout your project from start to finish.
We start by offering a FREE consultation to outlay all the steps necessary to complete a successful project. We can also help you finance your ADU and talk about how the Freddie Mac changes can help you.
Contact us today to get started on building the ADU of your dreams.
