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Granny flat loans

You can finance a granny flat with a home loan top up, a construction loan or a line of credit.

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A granny flat can give you extra living space and serve as an investment opportunity. And as a property owner, there are various ways you can finance the construction of the flat using the equity in your home.

How do I finance a granny flat?

According to Domain, Australian-made prefabricated granny flats can cost as much as $120,000. This is a significant cost, but could be well worth it for the additional space and potential rental income the unit will provide. But if you're looking to finance one, you'll need to consider your situation to determine which finance option is right for you.

Top up your existing home loan

A home loan top up is the process of increasing your existing loan amount. A top up uses the equity in your home to allow you to increase the home loan amount.

If you top up your home loan, your lender will perform a new valuation on your home and offer you additional funds based on the equity in your property. The equity is the difference between what your home is worth and how much you owe. For instance, if your home is worth $750,000 and you owe $600,000 on it, you've built up $150,000 in equity.

The benefit of a home loan top up is that it's the same loan facility as your original mortgage. You won't have to go through a new application process or pay additional establishment or ongoing fees.

The drawback to using this strategy to invest in a granny flat is that it can make your expenses difficult to track for tax purposes. If you're using your granny flat as a rental property, the interest on your loan will be tax deductible. But with a home loan top up, there will be no clear distinction between the repayments allocated toward your owner-occupied home and your investment granny flat.

Get a line of credit loan

A line of credit loan offers you a credit limit based upon the amount of equity you have in your home. Line of credit loans function much like a credit card, wherein you will only be charged interest on the amount you use rather than the full credit limit.

Using a line of credit to fund a granny flat investment can be a savvy tax strategy. Because you'll only make interest repayments on the amount you've used, you'll be maximising your tax-deductible debt.

However, one of the main drawbacks of a line of credit loan is the higher interest rate usually charged by these products. If you top up your existing loan, you'll continue paying your current interest rate. However, a line of credit loan will be a separate loan facility requiring a separate application process and will come with a higher rate.

Construction loans

In certain situations, it may be wise to use a construction loan to fund a granny flat. For instance, if you haven't yet built up enough equity for a line of credit loan or home loan top up to cover the cost of the granny flat, a construction loan may be a good option.

A construction loan will require you to use a builder, who will have to provide your lender with a signed contract and plans for the construction of your granny flat. You'll also need to obtain council approval.

The drawback of using a construction loan to fund your granny flat is that you won't be able to use a prefabricated granny flat. These units often don't require council approval and can be constructed quickly and simply. Using a builder to construct a granny flat can be a considerably longer and more costly process.

Compare construction loans

Data updated regularly
$
years
Name Product Interest Rate (p.a.) Comp. Rate (p.a.) Fees Monthly Payment

Greater Bank Great Rate Home Loan P&IHome≥ 20% Deposit

Greater Bank Great Rate Home Loan
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2.39%
2.40%
  • App: $0
  • Ongoing: $0 p.a.
$586
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Fund the construction of your new family home with a very competitive variable interest rate.

Suncorp Back to Basics Home Loan P&IHome≥ 10% Deposit

Suncorp Back to Basics Home Loan
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2.59%
2.60%
  • App: $0
  • Ongoing: $0 p.a.
$601
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A competitive variable interest rate loan with low fees. The establishment fee is waived if you borrow $150,000 or more.

loans.com.au Green Home Loan IOHome≥ 10% Deposit

loans.com.au Green Home Loan
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2.08%
2.39%
  • App: $0
  • Ongoing: $0 p.a.
$562
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More Info
Construction Loan: A competitive variable rate loan available for the construction of an energy-efficient home.
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Personal loan

If you're purchasing a prefabricated granny flat but haven't built up enough equity for a line of credit loan or home loan top up, you could consider an unsecured personal loan. These loans can be simple and quick to obtain, and don't come with the same restrictions as a construction loan. However, they also carry high interest rates relative to many other loan options.

Granny flats can be a great investment and offer you regular rental income. Getting your finance right will help make sure you get the best return on your investment.

Compare Personal Loans

Why add a granny flat?

A granny flat can add living space to your home and provide a private space for teens or adult children, or just a convenient spot for out-of-town guests. But a granny flat can also be an investment opportunity.

Granny flats are in rising demand in a tight rental market. According to 2016 data from Flatmates.com.au, granny flat listings as private rental accommodation rose 16% over the year, while searches for granny flats as rental accommodation increased a staggering 84%.

A granny flat can be a great way to generate rental income without purchasing an entire investment property. If the unit is self-contained with a bathroom and kitchen, and particularly if it has a private entrance, renting out a granny flat can be a reasonably unobtrusive experience for both the landlord and tenant.

If you're looking to generate income by adding a granny flat, you'll likely have to finance its construction. Fortunately, there are a number of options.

How much does it cost to add a granny flat?

The cost involved in adding a granny flat to your home varies depending on the type of granny flat you choose. But generally you'd be looking at a minimum spend of around $100,000 to get the new residence up and running.

If you're looking to build, there is also a huge range of options when it comes to the design and type of dwelling you want. From prefabricated and modular homes to dwellings built from scratch, your choice will be influenced by your budget, the designs available and the features you want to include in the granny flat.

If you're thinking of adding a granny flat to your property as part of a renovation or extension, then costs could head north of around $120,000. You'll also need to factor in engineering costs and possibly architect's fees, as well as money for any existing or potential hazards such as asbestos.

Tristan's Granny Flat Investment

Tristan granny flatTristan lives in a four-bedroom home on a 700-square-metre block in Sydney's northwestern suburbs. He has a significant amount of space in his backyard, which is a chore to maintain all year round, so he decides to add a granny flat as an investment that can earn him rental income.

Tristan decides a modular kit home is the right fit for his property, and spends a total of $100,000 getting the home built and installed on site, with all the plumbing and electrics connected. As his property is located within 500 metres of a train station, Tristan is able to rent the two-bedroom flat out to a young professional for $460 a week.

Factoring in a budget of $2,000 per year to cover maintenance costs, let's take a look at how long it will take Tristan to pay off his investment.

Rent: $460 a week

Total annual rental income: $23,930

Annual maintenance expenses: $2,000

Total income generated each year: $21,930

Time needed to pay off granny flat: 4.56 years

As you can see, at the current rental rate, Tristan will be able to pay off the cost of his investment in just over four and a half years. He can then start using his granny flat to generate disposable income.

Keep in mind that this is just one scenario and there may be a range of other factors to consider. For example if you have to borrow money to fund the addition of a granny flat to your property, it may take longer for your investment to generate positive cash flow.

What are the tax implications of a granny flat investment property?

Investing in a granny flatIf you rent out a granny flat to generate extra income, remember that you will need to pay tax on the rental income you receive. The amount of tax payable will depend on your income tax bracket and marginal tax rate.

The tax deductions you are eligible to claim will depend on whether your granny flat investment is positively or negatively geared. If the rental income generated by the granny flat is not enough to cover the cost of maintaining it (with loan interest payments and other ongoing expenses), then your property will be negatively geared and you can claim your loan interest payments and ongoing expenses as tax deductions. However, owners of properties that aren't negatively geared will only be able to claim their ongoing maintenance expenses as tax deductions.

You will also be able to claim the depreciation in value of your granny flat investment as a tax deduction each year. Just be aware that a Capital Gains Tax (CGT) liability usually applies to the portion of your property that you rent out.

How to minimise your CGT liability

Will a granny flat add value to my property?

If you're wondering whether a granny flat will increase the value of your property, the answer is yes - but only if it complies with all local council regulations. If you think your house will be more practical and better to live in with an extra independent living space out the back, chances are a potential buyer will think the same thing.

In many cases a granny flat can add significantly to the value of your property. However, you'll need to consider a range of variables when calculating your return on investment, including the size of the granny flat, its location and how much it costs to build.

Pros and cons of granny flat investment properties

Pros

  • Affordable investment. Buying or building a granny flat is usually cheaper than buying a standalone investment property, allowing you to start your investment portfolio without borrowing a huge amount of money.
  • Rental income. Depending on where you live and the size/features of the granny flat, your investment could provide several hundred dollars of rental income per week.
  • Adds value. A legally compliant granny flat will add to your property's total value.
  • Handy addition. If your circumstances change and you need somewhere for a relative or friend to live, your granny flat can provide the necessary accommodation.

Cons

  • Tenants. You'll need to be prepared to deal with tenants living on your property, which could potentially lead to some tense and awkward situations.
  • Cost. The cost of constructing a granny flat may be more than you expect and the expenses can quickly add up.

Image: Shutterstock

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