If you're looking to buy a family vacation home, chances are you'll need to get a mortgage for that property. A mortgage on a second home is different than a mortgage on a primary residence.
While some people can afford to purchase a second home using cash, most need to take out a mortgage. According to a survey by the National Association of Realtors Research Department, nearly half of all vacation home buyers and investors finance up to 70% of their purchase.
Here's an outline of things you need to know about financing a second home. This includes whether you can afford a second home, options for making a down payment and more.
Can I afford a second home?
Before you make this major financial decision, you'll need to find out if you can afford a second home.
First, add up all the costs. Not just the costs that go into the purchase, but the costs that might not be immediately obvious. These include your down payment and monthly mortgage payments, as well as closing costs, utilities, property taxes, insurance, landscaping, travel costs and other upkeep.
The differences between mortgages on primary residences and second homes
On your primary mortgage, you might be able to put as little as 5% down, depending on your credit score and other factors. On a second home, however, you will likely need to put down at least 10%. Because a second mortgage generally adds more financial pressure for a homebuyer, lenders typically look for a slightly higher credit score on a second mortgage. Your interest rate on a second mortgage may also be higher than on your primary mortgage.
Otherwise, the process of applying for a second home mortgage is similar to that of a primary residence mortgage. As with any loan, you should do your research, talk with multiple lenders and choose the loan that works best for you.
Qualifying for a second home mortgage
Before you apply for a second home mortgage, review your credit score, assets and income, just like a lender will.
To buy a second home, you’ll likely need extra money in reserve that could cover your mortgage payments in case you have a temporary loss of income. Well-qualified individuals likely need at least two months of reserves, while less-qualified applicants may need at least six months of reserves. One month of reserve funds should be enough to cover the monthly mortgage payment on both homes.
Debt-to-income (DTI) requirements for a second home mortgage may depend on your credit score and the size of your down payment. Generally speaking, the more you put down and the higher your credit score, the more likely your lender will allow a higher DTI.
Some homeowners might choose to offset their expenses by renting out their vacation homes when they're not using them. Doing this could violate your mortgage terms because you are using the property as an investment instead of a true second home, resulting in higher risk to the lender.
To qualify as a vacation or second home, typically, the property must:
- Be lived in by the owner for some part of the year
- Be a one-unit home that can be used year-round
- Belong only to the buyer
- Not be rented, or run by a management firm
Options for making a down payment on your second home
You have a few options to consider when making a down payment on your second home. You could use a cash-out refinance or open a Home Equity Line of Credit (HELOC) on your current home, or you can use your savings to make the down payment.
1. Cash-out refinance
If you have built up enough equity in your primary home, a cash-out refinance allows you to tap into that equity, especially if your home has increased in value since you bought it. Borrowers with good credit can typically borrow up to 80% of their home's current value. Before you go this direction, make sure you can afford the larger monthly payment you'll now owe on your primary home.
A HELOC, or home equity line of credit, on your primary residence is another popular option. If you have enough equity in your primary home, you can take out a line of credit and use those funds to make a down payment on your second property. This means you don't need to refinance your current mortgage.
Buying a second home may seem difficult, but if you know what to expect and review your finances, it could be easier than you think. Keep these factors in mind as you think about whether you can afford a second home, and how to get a mortgage for it.