Granny flat finance: how to pay for one, and whether the rent will count

Can you get a loan for a granny flat?

Yes, you can usually get a loan for a granny flat, as long as your income covers the bigger loan and council approves the build. Two common ways to pay for one are borrowing against the equity you already have in your home, or a construction-style loan that pays the builder in stages as the work is done.

Which of the two a lender offers you isn't only your choice. It depends on how much you already owe, what the lender is lending against, and whether the granny flat is a kit or built on site. Those rules are set out in the parts below, from the lenders' own policies.

Building for rent, or for family? Why it changes the loan

Whether you build a granny flat for rent or for family changes the question a lender asks. Built for rent, it's a second income from the same block, and the question is whether a lender will count that rent when it works out what you can borrow, and how much of it (part 12).

Built for a parent, an adult child or a carer, there's usually no rent, so the loan has to be paid from your own income alone (part 14).

What are the ways to pay for a granny flat?

There are five ways to pay for a granny flat, and they suit different situations. Which one you can use often depends on the lender's rules more than on your preference, and parts 4 and 5 set those rules out.

Can you use equity to build a granny flat?

Yes, you can use equity to build a granny flat, if there's enough of it and your income covers the larger loan. Equity is the part of your home's value you don't owe. The share you can usually borrow against is up to 80% of the value, less what you owe, because above 80% lenders mortgage insurance (LMI) normally applies [8].

On a $900,000 home with $400,000 owing, 80% of the value is $720,000, so the equity you could usually use is $720,000 less $400,000: $320,000 [10].

Lenders want to know what the money is for. Firstmac, for example, treats anything paid out to you as cash out, wants the purpose clearly identified, and won't accept a vague purpose such as "Personal Use" without detail. Up to $100,000, at 80% or under, it needs no further evidence where you give clear details; above $100,000 it wants documents, such as the builder's quotes or invoices [5].

There's more on how equity is worked out on using equity to buy an investment property, and on renovating with the loan you have on home loans for renovations.

Do you need a construction loan for a granny flat?

You need a construction loan for a granny flat when the lender is relying on what your home will be worth once the granny flat is built. One lender whose policy Money Brain has read assesses any home improvement as a construction loan when it relies on the value once the work is done [1]. The size of the job doesn't decide it; whether the lender needs the finished value does.

The same lender sets out a way around it. Where you owe 80% or less of your home's value as it stands today, and the loan isn't more than the value of the land, it may approve a standard loan instead: no building contract or council plans needed for the approval, no progress payments, and the lender doesn't control when the money is paid out. The work mustn't have started, a licensed builder has to be engaged for any structural work, and you show the build cost so the lender can see you can finish [1].

What this means for you: if you already have plenty of equity, a granny flat may not need a construction loan at all, and that saves you the stage-by-stage paperwork. If you need the finished value to make the numbers work, expect a construction loan, with everything in the next three parts.

How does a construction loan pay for a granny flat?

A construction loan pays for a granny flat in stages, as each part of the build is finished and checked. One lender whose policy Money Brain has read treats five stages as standard and accepts up to eight [1]. Here is its standard schedule, set against a $150,000 building contract as an example (not a quote):

Before each payment, the lender usually sends a valuer to confirm the stage is done. Firstmac orders a progress valuation at every stage where a payment is asked for, and pays any money of your own to the builder first, before a single stage is paid from the loan [3]. While you build, you pay interest only on what has been paid out so far. At an illustrative 6.5% a year, $60,000 paid out after the frame costs about $325 a month in interest; the full $150,000 costs about $812.50 a month [10].

Worth knowing: a contract that asks for much more than these stages early on is the risk that lender names. It's concerned about contracts that pay the builder more than the share of work done, because that leaves you exposed if the builder fails before the job is finished [1].

Can you finance a kit, modular or tiny granny flat?

Financing a kit or relocatable granny flat is harder than financing one built on site. One lender whose policy Money Brain has read won't lend for kit or demountable homes at all [1], and the lender policies we've read refuse owner-builders, so at that lender a kit you put up yourself is out on both counts [1].

A tiny home on wheels is a different thing again: a home lender lends against your property, and something that can be towed away usually isn't treated as part of it. If you're looking at a prefabricated granny flat, ask how the lender will treat it before you pay a deposit to the supplier.

Can you build a granny flat and a duplex, or more than one?

Building more than one extra dwelling on a block takes you outside what some lenders fund. One lender whose policy Money Brain has read won't lend to build more than two dwellings, and won't lend to builders or developers building to sell [1]. A home with one granny flat is two dwellings; anything beyond that is a development question, and it's worth asking about early.

How much can you borrow to build a granny flat?

How much you can borrow to build a granny flat is set by two limits: what the lender will lend against the property, and what your income can repay.

The first limit is lower for building than for buying. One lender whose policy Money Brain has read lends up to 80% for construction, measured on the lower of the finished value and the cost to build [1], against up to 95% on its standard home loans [2]. So a granny flat that values up when it's finished doesn't, on its own, let you borrow more there.

The second limit is your income. Lenders check you could still repay if rates were at least 3 percentage points higher than your loan's rate [6]: a loan at 6.5% is tested at 9.5% or more [10]. And APRA limits how much new lending can go to people whose total debts are six or more times their income, counted separately for home buyers and investors [7]. See how much can I borrow.

Firstmac also keeps back enough of a construction loan to finish the build, as its own valuer estimates the cost to complete, whatever the contract says [4]. If its valuer thinks finishing will cost more than what's left in the loan, you can be asked to cover the gap.

What if the build takes you past 80% of your home's value?

If a granny flat takes your loan past 80% of your home's value, lenders mortgage insurance normally applies, and you pay for it [8]. Say your home is worth $850,000 and the loan after the build would be $700,000, about 82% of the value. On one insurer's published rate card, LMI on that loan would be about $7,910 [8][10].

That's an illustration from one rate card, not a quote. Premiums vary from lender to lender and insurer to insurer, and some lenders won't lend past 80% for a build at all (part 10).

Will the bank count the rent from a granny flat?

Whether the bank counts the rent from a granny flat depends on the lender, and it's the question that decides whether a granny flat built for rent stacks up. Some lenders count expected rent; some count it only once it's leased; some don't count it at all, or only where the granny flat is approved as a separate dwelling.

Lenders' rules for granny flat rent aren't in the lender policies Money Brain holds, so we don't publish a list of who does what. We check it lender by lender for your build, before you sign anything.

What this means for you: two lenders can give two quite different answers on the same granny flat. Rent counted can lift what you can borrow to build it; rent ignored means your own income carries the whole loan.

Expected rent or a signed lease: what a lender needs to see

To count rent from a granny flat, a lender needs evidence of it. Before the granny flat exists, that's usually a rental appraisal, an estimate from a property manager. Once it's let, it's the lease or the rental statements, showing the rent per week and who manages it.

Lenders usually count less than the full rent, to allow for weeks it sits empty and the costs of owning it. So budget on less than the appraisal, not all of it. Every $100 a week of rent is $5,200 a year before costs [10].

Building a granny flat for family: what changes

When you build a granny flat for family, the lender usually looks only at your income to cover the bigger loan, because there's no rent coming in. If the family member living there pays something toward costs, it usually doesn't count as income unless there's a formal arrangement the lender accepts.

That makes the borrowing test on your own income the one to pass. It's worth knowing your number before you promise anyone the space.

If a parent is helping pay for the granny flat

If a parent or other family member is helping pay for the granny flat, how it's set up matters for both of you. Money can be a gift, a loan, or a share in the property, and a lender treats each one differently.

Get advice on the arrangement, including on tax and any pension, before any money changes hands, and tell the lender about it at the start. A family loan the lender finds later can change your application.

Does a granny flat add value to your home?

A granny flat often adds less to a valuation than it cost to build. Valuers look at what buyers in your area would pay for a home with one, and that depends on the street, the block and the quality of the build.

What this means for you: if you're counting on the added value to repay the loan, or to refinance later, have the numbers checked before you commit.

Is a granny flat a good investment?

Whether a granny flat is a good investment comes down to three numbers: what it costs, what it rents for, and what the money costs you. Run them before you build.

As an example, $150,000 borrowed at an illustrative 6.5% a year costs about $9,750 a year in interest [10]. Set that against the rent you'd really keep after empty weeks, rates, insurance and upkeep, and against any value the valuer gives it. What it does to your tax is a question for your accountant.

What does a granny flat do when you sell?

A granny flat can widen or narrow your buyer pool when you sell. It can draw families wanting room for a parent and investors wanting two rents, and put off buyers who just want a yard.

That's another reason the value it adds can be less than it cost: you're paying for something only some buyers want.

Do you need council approval for a granny flat?

Whether you need council approval for a granny flat depends on your state and your council. States set their own rules, and councils add their own requirements for block size, setbacks and the size of the second dwelling. Check before you pay for plans.

Approval is a lending question too, not just a building one. The lenders whose policies Money Brain has read want council-approved plans before the builder's first payment [1][4], so a build that stalls at council stalls the loan with it.

Can you rent out a granny flat in Queensland?

Yes, you can rent out a granny flat in Queensland to anyone, not just to family. A secondary dwelling has to be secondary to, and go with, a main home on the same block, and it can't be built on its own. The state's planning department still says to speak to your council about whether you need development approval [9].

Other states set their own rules, so check with your council before you plan on rent.

Can a granny flat be sold separately?

A granny flat usually can't be sold separately. It sits on the same title as the main home, and in Queensland a secondary dwelling can't exist without a main one [9]. Selling it on its own would mean subdividing the land, which is a separate approval with its own requirements, and isn't possible on many blocks.

Build a granny flat, or buy a home that already has one?

Building a granny flat and buying a home that already has one are two routes to the same thing, and they carry different risks.

Buying one is the work of Property Brain, our buying advocacy side: see Property Brain.

What does a broker cost you?

How a broker is paid, and the rule Money Brain holds against it, is set out in full on its own page: what a mortgage broker costs.

Your first move

You've read the rules. Now there's one question left: which way of paying, at which lender, for your build on your block? That depends on what you owe, what your home is worth, what the granny flat will cost and whether it's for rent or family, and it's what Money Brain works out before anything goes to a lender.

When you're ready, the closing section below is the simplest way to start.