Thanks, everyone, for all the detailed feedback. (Extra points to uniwelder for cross referencing this question with my other posts!!). We actually recently refinanced our mortgage, so missed our option to do a cash-out refinance.
The questions you raised gave me some good next steps:
-I'm talking to a real estate agents to see how this would impact the value of our home/lot--and about whether we could subdivide the lot (thanks for mentioning that possibility, mountainfamily)
-I'm having someone come out to give me an estimate about building costs on our lot (part of what set this is motion is that there are now seattle-based companies that are doing backyard cottages with all steps included (you pick a model and they take care of the rest; for example, this one:
https://mykabin.com/model/kenai-traditional/). My husband and I are happy to paint some walls or do some landscaping, but aren't interested in big complicated construction projects.
I did put some numbers into spreadsheet that chpbstrd referenced. Based on on some conservative numbers I put in, we could get an 8% cash ROI and, depending on what the value of the 2nd home would be, a 200% ROI (or more) when factoring in equity. (While we are staying in Seattle for the near future, moving to a LCOL area is part of our longer term plan).
If anyone has more advice or suggestions based on this additional information, I'm happy to hear it! Otherwise, I will come back with updates when I have more information from the real estate agent and builder.
Thanks everyone!