How to Get Around ADU Owner Occupancy

In the state of California, there’s no more requirement for owner occupancy if you decide to build an ADU. However, owner-occupied property still has several benefits in comparison with rental property. So, if you want to buy yourself a second home for business but have no intention to live onsite, there are a few issues that may arise.

Let’s explore how owner occupancy affects your approach to ADU management and what it has to do with your loan payment requirements.

ADU on Owner-Occupied Property

Before September 2023, there was a rule in California state law that, as a property owner, you couldn’t live outside the premises. So, if you built an ADU, you either had to live in the primary residence or on the same land but in the accessory dwelling unit.

However, since that time, the regulations have relaxed. Currently, property owners can not only construct an ADU on the rental property but also lease all the residential units on the land, including the principal residence. This leeway opened great opportunities for increased rental income under the condition that you abide by all short-term rental rules. This means that if your city doesn’t allow rentals for periods less than 30 days, you must not break this rule.

Nevertheless, if homeowners choose to build both an ADU and a JADU, owner occupancy applies. In other words, you or your family members should live in the primary home or in the small extra unit (JADU). If you move and don’t occupy the property anymore, you lose the right to rent the JADU out.

In conclusion, we need to note that despite mitigating the owner occupancy clause, there are still cases when it applies, which serve as an obstacle to renting.

Owner-Occupied Property: What Is It

Owner-occupants are people who own or occupy the property. An owner-occupied home is a home where you live most of the time (around 70% of the time). Usually, an owner-occupant can provide proof of living in the house for at least one year. These proofs may be such documents as utility bills that demonstrate that you use the property on a daily basis.

So, can a company be an owner-occupant? According to these rules, no. Since businesses are legal constructs that cannot occupy any land in the same sense as people do. Therefore, they will not be able to rent out both an ADU and a JADU. However, they can still use ADUs as investment properties.

For instance, a company can buy an ADU as their investment property and offer it to tenants. This tenant who pays rent, in turn, may receive not only the opportunity to enjoy the property but also some share in the company.

Owner Occupancy Benefits

Besides the opportunity to rent both an ADU and a JADU, property owners who really live in their primary residence (or ADU) enjoy a whole number of great advantages. These include:

• Taxes 

If you rent out both your primary residence and an ADU, you cannot apply for tax deductions that the laws foresee for owner-occupied properties;

• Easement of regulatory burden 

Owner-occupants have fewer rules and regulations to deal with when it comes to real estate remodeling or building (as we see with JADUs);

• Lower insurance premiums

If you live on the property, insurance companies see your household as less risky.

• Owner-occupied loan 

An owner-occupied mortgage has more beneficial terms for the borrower.

These are some of the numerous reasons why investors may want to use the benefits of owner-occupied property intended for homeowners, sometimes even committing owner-occupancy fraud. Now, let’s also look at financial incentives a little closer.

Owner-Occupied Financing

A real estate investor receives an opportunity to choose between various loans with lower interest rates rather than resorting to non-owner-occupied loans. Such loans also have better down payment requirements and offer simpler financing variations (for example, dealing with one mortgage both for primary residence and other units rather than multiple).

If the mortgage lender is an owner-occupant, they can make use of the following loan options:

• FHA loan

Government-backed loans such as FHA loans allow lenders to make very small down payments (3.5% of the sum). They have minimum requirements for the borrowers. Also, in certain cases, you can ask them to include closing costs in your loan. These loans are available only to those home buyers who are going to live in their primary residences. However, if you do so, you can buy land with up to four units on it.

• VA loan

VA loans are only for veterans or military personnel. These loans allow for a 0% down payment (except you need to pay a VA funding fee). They also don’t demand that you have private mortgage insurance.

• Conventional loan

Conventional loans require a good credit score (620 min.). Also, they have harsher requirements for a loan application. If the percentage of your monthly income going to pay debts does not exceed 50%, you may qualify. The downpayment for this loan type is 3%, though.

All in all, if you’re a homeowner who has the possibility of really occupying the land you bought property on, it will help you save good money.

Occupancy Fraud

We have already discussed numerous reasons why investors might want to get all the benefits of owner-occupants. It sounds so attractive to live in the second home and rent out the first one, especially if it’s more than one unit.

However, you need to understand that when you take an owner-occupied loan, you sign a legal document that brings forth consequences in case of breach. Also, occupancy checks are performed in order to prevent bank fraud.

For instance, when you ask the mortgage company to send your bills to another address in year one, they may start to have some suspicions. Or, if ten years later, you apply for another mortgage and the lender conducts a credit check, discovering that you own a home, but it’s address doesn’t coincide with the one on the loan application.

Occupancy fraud (a type of mortgage fraud) is a federal offense, no matter whether committed against the state or against the bank. And there will be serious penalties if you get caught. In the United States, a convict can face up to 20 years of prison time with a potential fine of $5 million. 

Although the average time spent in prison is 14 months, this crime doesn’t allow probation. Of course, they can also confiscate the property involved in the scheme. Moreover, all accomplices, like a real estate agent or a government agency, are also liable.

Exemptions

Occupancy fraud requires malicious intent. Let’s imagine you actually planned to live in a house. But suddenly you got ill and now need constant care of your family member. You have to move together with your relative and lease your home with a JADU to tenants because you have to pay the mortgage somehow. This doesn’t constitute occupancy fraud.

Another example is when you get fired after receiving a loan and have to go to another town for your new occupation. Or one of your loved ones suddenly needs long-term care. Or even if you meet someone and go on a honeymoon trip around the world for a couple of years.

Summing up, if the homeowner lacks fraudulent intent from the beginning, it exempts them from the punishment for mortgage fraud, if proven.

Frequently Asked Questions — FAQ

How do lenders know if it’s your primary residence?

The lender issuing a mortgage can determine what place you occupy most of the time by checking where you receive your mail, what’s your legal address for tax returns, where you work, and if a job transfer took place. Also, they may demand such proof as utility bills or voter registration.

Does the FHA check owner occupancy?

Indeed, the FHA loan officer verifies if you occupy the land during the mortgage application process. After you complete the last steps in getting an owner-occupied mortgage, you must move into the property within 60 days. The loan lender can also conduct occupancy checks after this to make sure the goal of the property purchase was to live on the plot.

What makes a property owner-occupied?

If you live on the same land as your tenants, it occupies your property owner. It doesn’t matter if you live in a primary residence or in an ADU. The key factor is that you use your property for living most of the time.

What is the owner-occupied clause?

An owner-occupied clause is a condition under which you can rent out your JADU. If you’re renting only your ADU, since 2023, you don’t have to stay on the same land as your tenants. However, living in the main house may allow you to rent two units: an ADU and a JADU, which is a good opportunity for investors.