How to Finance a Detached Structure

For a homeowner looking to increase the value of their property, and add usable space, a detached structure such as a garage or shed can be a smart way to build home equity.

It can be expensive to pay for the construction of a new, separate structure, but there are ways to finance these types of home improvement projects. The type of financing that will make the most sense for your budget will depend on such factors as how much equity you have in your home and whether you have good credit.

Whether using a home equity loan, a renovation loan or a personal loan, here’s what you need to know about financing a detached structure.

Types of detached structures

Common types of detached structures include a stand-alone garage, a guest house, a shed and a carport. If you need access to cash to build a detached structure, you may qualify for certain types of financing if you have at least 15% to 20% of equity in your home along with a good credit score. Many lenders prefer to see a credit score of at least 700.

Detached garage

Building a detached garage offers homeowners an 80% return on investment on average, and can cost between $16,000 and $40,000, according to HomeAdvisor, which cautions that the cost of some building materials, including siding, has increased between 5% and 10% this year. If you’re building a high-end three car garage, it could cost as much as $110,000, according to Fixr. Remember, the interest rate on your financing also plays a role in the final cost of your home improvement project.

Guest house

The average cost for building a 600-square-foot guest house is $55,000, HomeAdvisor estimates, but that can range anywhere from $5,000 to $100,000 (or as much as $300,000 for a high-end unit in an expensive neighborhood). If a guest house is built and used properly, it can provide a high return on investment, or ROI, because of its rental income potential. 

Barn or shed

Depending on size and quality, you can spend anywhere from a few hundred dollars to as much as $30,000 for building a shed or small outdoor storage unit, according to HomeAdvisor. If you’re building a larger structure, such as a barn, be prepared to spend between $10,000 and $200,000, Fixr estimates.

Carport

Like a garage but with some of the sides removed, a carport also offers an ROI of at least 80%, according to remodelingcosts.org, and will cost, on average, between $2,000 and $10,000, depending how bare bones or high-end you want to go, says Fixr. 

Determine what you want to build and why

First decide what you’ll use your detached structure for and whether the investment makes financial sense to you. Consider working with a financial advisor to evaluate your long-term goals and whether this type of construction project makes sense. 

Here is a checklist of what you need to ask yourself before investing your time, resources and money:

• What are your short-term and long-term financial goals and constraints? 
• What will you use your new detached structure for? 
• How long do you plan to stay in your home?

Once you’ve determined your goal, call lenders and contractors to compare quotes and begin outlining a budget. 

How to estimate your costs

Interview various builders and contractors, and talk to people who’ve completed similar projects and research price ranges from different sources. You’ll need to determine how each element of the build will affect your total budget. Consider the costs for such things as: 

• Do-it-yourself costs vs. labor costs
• Contractor and builder rates
• Working with architects, designers or engineers 
• Complexity of the construction (additional electrical outlets, plumbing) 
• Material costs including quality and availability

In today’s economic climate, it’s prudent to add a contingency to your budget given issues such as global supply chain problems, commodities shortages and geopolitical instability. If your contractor experiences a delay of a lumber shipment, it could increase the cost of your project.

Ways to finance your additions

Some homeowners have the ability to pay for home renovations upfront in cash, but for many financing such an expensive project with a loan paid back over time is more realistic. Key differences between the types of financial products include the interest rate and the terms of how the loan will be paid to the bank or lender.

A home equity loan and a home equity line of credit, for example, each have lower interest rates than personal loans or credit cards because they are secured loans that require the homeowner to put up their home as collateral should they fail to pay back the loan. This enables the bank to offer a lower interest rate. If you choose to finance your project with a credit card, you’ll likely pay a higher interest rate, but the bank can’t repossess your home if you fail to make your payments. 

Home equity loan

A home equity loan provides you with a lump sum of cash at a fixed interest rate by borrowing against the equity you’ve built in your home. With this option, you have consistent monthly payments, with a typical repayment period of between five to 30 years. 

One of the biggest benefits of using a home equity loan for home renovations is that the interest is tax deductible, which will save you thousands of dollars over the life of your loan.   

HELOC

A HELOC is a loan that lets you borrow against the equity in your home and functions like a credit card that you can access the funds for a period of time (usually 10 years), and then pay back over a repayment period (usually 20 years). A HELOC is useful when you don’t know exactly how much money you’ll need, or for how long, because you can continually make withdrawals over time as you need more funds, or not take out your entire line of credit if you need less.

“HELOCs have grown in popularity as a large percentage of homeowners are now locked into historically low rates, and they have also been left with record equity in their homes as prices have risen,” says Paige Hawley, senior origination manager at Morty, an online mortgage marketplace.

But you can get hit with sticker shock once your repayment period begins, and you won’t have started paying down your principal balance yet. A HELOC also has a variable interest rate, which means your payments can fluctuate monthly, unlike with a home equity loan. Be sure to plan for a range when you budget your monthly HELOC payment.

Cash-out mortgage refinance

A cash-out refinance replaces your existing mortgage with an entirely new mortgage and provides a homeowner with a lump sum of cash to use for such projects as home renovations. That lump sum gets added back to the balance of your new mortgage and can be paid off as one monthly payment, usually at a lower interest rate than the original mortgage. However, since mortgages rates surged past 7% at the end of September, it’s unlikely a cash-out refi is advantageous for most homeowners right now.

“Overall, mortgage rates have gone up significantly, which can make any kind of refinance less attractive and less beneficial when compared to holding on to an existing mortgage and paying down other debts in a different way,” cautions Hawley.

FHA 203(k) loan

A FHA 203(k) loan is a home renovation loan secured by the Federal Housing Administration that allows a qualifying homeowner to roll the cost of home renovations into their mortgage, creating one loan. This consolidates your borrowing costs and your mortgage into one monthly payment, simplifying the repayment process. There are benefits to FHA 203(k) loans, such as the option for upfront funding, but a major downside is that your renovation work must be completed within six months -- which could be risky given ongoing shipping and supply chain delays.

Personal loan

A personal loan will usually have a higher interest rate than an equity loan because it isn’t secured and is riskier for the bank. A typical repayment period is 10 years, but the terms of the loan will vary by lender. This type of credit can be easier to approve because you don’t have to be a homeowner to qualify. But as with any loan, the higher your credit score, and the healthier your financial life, the lower the interest rate you’ll receive.

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