Buying a second home can be tricky, but with preparation and some help from experts, you can make an informed decision that’s right for your situation.
Decide what you can afford
An essential first step in deciding if you should purchase a second home is determining if you can financially afford to do so. Interest rates for second mortgages are usually a quarter to half a point higher than first mortgage interest rates. If you haven’t paid off your first mortgage, your lender will want to know that you can afford both mortgages along with other costs such as insurance, fees and taxes. Finally, down payments for second mortgages tend to be higher, sometimes requiring 20% or more of the total purchase price.
Decide the type of second property you want
People routinely use the terms “second home” and “investment property” interchangeably, not realizing the differences between these two types of properties.
A second home is one that you plan on living in, in addition to your primary residence for certain parts of the year. This can include a vacation home, retirement home or a condo in a location where you frequently conduct business. To qualify for a second-home loan, it must be located a specific distance from your primary residence or in a vacation or resort area such as near the ocean or by mountains.
Investment property is real estate that is not a primary or secondary residence for you or your family and has a primary purpose of generating income, taking advantage of tax benefits and profiting from appreciation. There are two main kinds of investment property:
- Residential rental property: a home you buy with the intent to rent out to others to make a profit
- Purchase and flip property: a "fixer-upper" home that you buy with intentions to make updates and improvements to and sell for a profit
Getting a second mortgage
If you are planning on securing a loan to buy either a second home or investment property, it’s essential to know the differences between the two types of properties and clearly state your intentions to your lender at the start of the mortgage application process. Doing so will help make sure you apply for and receive the right type of loan for the type of property you intend to buy.
Just like your first mortgage, you can prequalify and receive a conditional approval letter for a second mortgage before starting your property search. Interest rates for second mortgages are generally higher than first mortgages. Making a larger down payment, and having to borrow less, may help you get a lower interest rate for your second mortgage. Your lender will also want to know your current credit score and debt-to-income ratio.
A mortgage for a second home will generally have a lower interest rate than a mortgage for an investment property. A second home mortgage will also typically include a second-home rider ensuring the following:
- You or your family will occupy the second home and only use it as a second home
- The property will be available for your exclusive enjoyment and use at all times
- The property is not part of any rental pool or timeshare arrangement
- There is no agreement in place requiring you to provide a management company or another individual the ability to use or rent the property.
Most lenders will not offer you a second-home mortgage if you plan to rent the home out for any time period. For example, you can qualify for a second-home mortgage if you live in the home during the winter, and it remains vacant for the rest of the year. If you are planning to live in the home during the winter and rent it out the remainder of the year, an investment property mortgage may be required .
Planning for additional costs of a second home
It’s important to thoroughly analyze all the costs associated with the purchase of a second home and be sure that you’re able to afford it. Remember, a second mortgage is just part of the equation.
Lenders may require 20% or more down payment and second home lending is not offered in many lower down payment programs, such as FHA. If this is a property you plan to rent, plan for up to a 30% down payment. You should also expect a higher interest rate on a second home, not to mention higher demands on qualifiers such as credit score and income level.
If you’re considering using the equity in your first home to help pay for your second one, you may want to speak to a financial advisor to help determine if this option is financially sound for you. Remember: the equity will no longer be available should you need it in the future.
Since you won’t be at the property full time, you’ll want to consider hiring someone to monitor it for you while you’re gone or be responsible for renting it out during those times if you’re looking to utilize it as an income property. While there is a cost associated with this that you’ll need to factor into the affordability quotient, the peace of mind you’ll have while away will more than justify the expense.
Insurance and taxes
Depending upon the location of your second house, you may find it harder to get the coverage needed. Beach homes, for example, will typically require additional flood protection that can be difficult to obtain.
Also, taxes will vary depending on how you choose to use the residence. If this is a true second home, you may be able to allow for more deductions than if used for an investment property. There are many rules and stipulations at both the federal and state levels, so consulting with a financial advisor to understand the potential costs thoroughly is highly recommended so that there are no surprises.
Unless the property you’re looking to purchase is already furnished, and just the way you’d like it, chances are you’re going to need to do some furniture shopping. Not only that, but you may decide you’d like a different color paint on some of the walls or a new fixture or two — all things you’ll want to keep in mind when calculating out the expense of purchasing your second home.
Additionally, unless your homes are close enough to each other that you can pack up and bring some of the necessities each time, you’ll need to purchase things like dishes, pots and pans, towels, sheets, bathroom supplies, cleaners and more.
Maintenance, utilities and repairs
Just like your first house, there’s no getting away from these things on your second one. When researching the location of your second home and associated expenses, remember to take into consideration things like landscaping and potential weatherproofing. For example, if you’re purchasing somewhere that has a lush garden, that garden will need to be maintained even when you’re not there. The same holds for things like swimming pools, where they may need to be closed during the winter and reopened in the spring. Perhaps your second home is in an area that could be threatened by weather systems, such as tropical storms or hurricanes. You’ll need to make sure you’re adequately prepared and have people in place who can access the home and take appropriate measures if necessary.
There’s also the cost of utilities and repairs as they come up. If you choose a property manager, they can take care of most of these things in your absence. They would also be the contact for renting out the property if you wanted to do so when not staying there yourself. When the microwave goes out though, or the plumbing backs up, you’ll want to ensure that you’re in a comfortable enough position financially to be able to tackle these things (or have them tackled for you) without frustration.
While a second home, vacation home, income property or future retirement location may be a wonderful idea, it needs to be something you can comfortably manage financially so that it can genuinely be the escape you’re looking for. A second mortgage means more financial obligation, but it could also be the perfect investment for your portfolio and future.
To be thoroughly comfortable with your decision, let Chase help you put together a team of experts including real estate agents, property managers and, of course, financial advisors. Between them all, as well as feeling secure in your financial capabilities, you should feel comfortable on absolutely every single level of your decision to invest in a second home.