If you’re one of the many Americans who spend their summers or winters renting a second home, then you might want to pay attention. If you frequent a destination often enough, you may find it worthwhile to put the money into a mortgage rather than rent. There are a few different ways to finance a second home or vacation property with benefits beyond calling the place your own. We aren’t saying this is always an easy undertaking, but it’s one that’s worth checking out.
Why invest in a second home or vacation property?
The definition of a second home
Before going any further, let’s define what exactly a “second home” is. It’s important to understand the difference between a second home and an investment property, because they are treated differently by lenders and the IRS.
Homing in on the definition of a second home can be difficult because different lenders define it in different ways. A general definition can be a property you plan to live in for part of the year that is not your primary residence. Some lenders may require you spend a certain number of days there. Others may require the property to be a certain distance from your primary residence. Some lenders may allow you to rent the property out and still consider it a second home, while others will not. If your lender doesn’t consider a property a second home, then it’s treated as an investment property.
Potential tax benefits
Second homes are typically easier to finance than investment homes. They may also be eligible for mortgage interest tax reductions. A mortgage interest tax reduction is an itemized deduction that lets homeowners deduct interest on a home improvement loan from taxable income. Check with your personal tax advisor for more information.
Real estate typically appreciates in value, meaning the price of your home will likely go up over time. This can be a safe asset for your financial portfolio and one you’d likely profit from in the future if you sell.
Depending on the terms of your loan, you may even be able to rent out your second home and make money to put towards your loan in the short term. Rentals usually fall under investment properties, but your lender may allow you to rent out your home if you’re still living there for a certain portion of the year.
You’re already spending the money
If you’re someone who vacations in the same place every year, that means you’re already spending the money on rent. Renting has its own benefits and isn’t necessarily throwing away money as some people put it since you’re still receiving a place to stay and memories in turn. But if you’re already spending the money, then having even more to show for it may be worthwhile. You can turn this investment into something that could pay you back in the future or be passed down through your family.
How to finance a second home or vacation property
If you have the liquid assets available to finance a home, this is usually the best option. But this isn’t the most realistic option for a lot of us. Here are some things to keep in mind before looking at mortgages:
- May need more cash upfront than you did for your primary residence.
- Must occupy the property for a certain portion of the year.
- May not be able to rent the property out.
- Often higher credit score requirements.
- Loans often come with lower interest rates than investment properties but are still higher than primary residences.
- If you are using this purchase as an investment, remember that it is a long-term strategy.
Loan, refinance & other finance options
1. Conventional loans
Like you probably did for your primary residence, the option to take out a conventional loan for your second home is possible too. A conventional loan involves monthly payments towards your interest and principal. Your monthly payments will depend on the price of the house you’re purchasing, your down payment amount and your personal qualifications like debt-to-income ratio and credit score.
If you’ve owned your primary residence for a while, you may have a decent amount of home equity. A cash-out refinance replaces your current mortgage and borrows against the equity in your home. You can use the extra money as cash towards other life expenses, like a down payment on your second home.
3. Home equity loan
A home equity loan allows you borrow against your home equity as well but instead of replacing your mortgage, it acts as a second one. You’ll be making separate payments towards your home equity loan. Since it is a second mortgage, it usually comes with higher interest rates.
4. Shared ownership
Another possibility for financing a second home or a vacation home is going in with other family and friends. This can make it more affordable and even more fun!
With the right preparation and tools, financing a second home could be a reality for you. Whether it’s refinancing your primary residence, taking out a second loan or going in with a family member, there are many avenues to explore. Speak with your Home Lending Advisor today to see the best plan of action.