Buying A Second Home Might Be Your Smartest Move
Hotels are great, but they are certainly not a good investment. Second homes, on the other hand, potentially yield a return while providing a vacation spot over which you have 100% control. Home prices are up nationwide by more than 5% since last year. That means your vacation home might pay for your vacation. You skip the booking hassles. If you’ve grown weary of spending your summer in hotels and vacation rentals, consider joining the nearly one million buyers who purchased second homes last year. But buying a vacation home is not a sure-fire win. And, it’s different than purchasing a primary residence. Here’s what you need to know before jumping in.
Understand Total Costs
Owning a second home comes with extra responsibility. You’ll be maintaining two households, and that could be more expensive than you planned for. So plan carefully. Affording the total cost is different than qualifying for the mortgage. Mortgage underwriters only look at expenses for principal, interest, property taxes, insurance, and, if applicable, HOA dues. If these expenditures check out, they approve your loan. You must consider travel costs, regular maintenance, repairs, utilities, furnishings and household items. You might offset some or even all of the costs if you rent your home part-time. You may also be able to write off your mortgage interest and property taxes to reduce overall cost.
Is A Rental The Same As A Vacation Home?
Rental homes and vacation properties are financed differently. If you can qualify for your purchase without the property generating any income, buy it as a vacation home. You’ll get a better interest rate and qualifying is more straightforward when rental income is off the table. However, if you need to rent out your place to afford it, it becomes an investment property, not a second home. In this case, your lender will want to see an appraisal with a comparable rental schedule. This document tells the underwriter the property’s potential income. The lender counts 75 percent of the anticipated rents as income to you, and the monthly mortgage, taxes and insurance are added to your expenses when calculating your debt-to-income ratio (DTI). Investment property mortgages almost always require at least 20 percent down because it’s very difficult to get mortgage insurance for these purchases. Investment property mortgage rates can be 50 basis points (0.50%) percent or higher than rates for primary residences.
Second Home Downpayment Requirement
You can buy a primary residence with just three percent down in many cases, but it takes at least ten percent down to buy a vacation home, and that’s if your application is very strong. Otherwise, your lender may require at least 20 percent. If you don’t have a lot of cash on hand, you may be able to borrow your downpayment. About one-fifth of buyers tap into equity from their primary residence to make the downpayment on the second home. What about FHA or VA loans? Unfortunately, Uncle Sam has doesn’t back loans for anything but primary residences. However, if your seller has a government-backed loan against the property, you may be able to assume it. Your loan of choice will probably be a conventional loan, offered by lenders nationwide, and underwritten by standards set out by Fannie Mae and Freddie Mac.
Qualifying For A Second Home Mortgage
Vacation property loans have only slightly higher rates than do primary residence mortgages. To make sure you qualify in the first place, assess your standing in the following areas.
Assets needed for a vacation home purchase
When you buy a vacation property, you’ll probably need reserves. Reserves are funds available to pay your mortgage if you experience an interruption in income. You’ll need at least two months of reserves if you’re a well-qualified wage earner, and at least six months if you’re self-employed or have any weaknesses in your file. One month of reserves is equal to the amount of money it would take to make one months’ payment on both your primary residence and future second home.
Credit score to buy a second home
Credit score requirements are slightly higher for second homes than for primary ones. For example, Fannie Mae sets its minimum FICO at 620 for primary home purchase loans with at least 25 percent down and 640 for vacation homes with downpayments of 25 percent or more.
Income required for a second home
Debt to income requirements depend on the size of your downpayment and credit score. For example, Fannie Mae allows a DTI up to 45 percent with a 660 FICO and at least 25 percent down. A 45% DTI simply means your total monthly payments add up to forty-five percent of your gross income. For example, if you make $10,000 per month before taxes, your total payments including your primary residence, second home, auto loans, and other loans, equal $4,500. Unlike investment properties, vacation homes have no rental income to offset the mortgage payment. You have to qualify with income coming from sources other than the property you are purchasing. If you wish to purchase a multi-unit vacation home, most lenders will treat it as investment property, whether or not you plan to rent it out.
Second Home: It’s Still A Business Deal
It is tempting to jump into a vacation (second) home purchase, but first, weigh the benefits and costs.
Ensure that it makes long-term financial sense to buy. While there are upfront costs, a second home purchase can be a nice addition to your real estate portfolio or retirement plan.