You may have located your favorite vacation spot, and would like to consider buying a home there – perhaps for future retirement, or just as a place to enjoy part-time. If you do decide to purchase, will there be a significant difference in acquiring a mortgage for your vacation home? If you are seeking conventional financing, the process is going to be very similar, but the criteria will be somewhat different.
As with your first home, the lender is going to evaluate your risk – and will be weighing the same factors, with a few added concerns.
- Intent of Second Home – How often do you intend to use the second home, and do you intend to rent it out when you aren’t using it?
If you rent it out for fifteen days or more in a year, it is considered rental property and falls under a different, higher set of risks (and also tax ramifications). Higher risks equal a higher interest rate. Check with your lender on whether rental income can be included as income in the loan evaluation; the rules vary by lender.
- Extra Risk/Cost Factors – Does the location of your second home increase your risk or your costs? For example, if it is near a beachfront area, you may need flood or hurricane insurance. If you are buying a cabin in a remote area, it may require extra winter maintenance. If you are purchasing in a managed community, there may be a series of maintenance, membership or management fees to pay.
- Debt-to-Income Ratio (DTI) – Just as with your first mortgage, your DTI ratio is a key indicator for lenders – and if your first home is not paid off, you will have two mortgages to include. Your collective DTI will still need to be below 36%, with total housing payments no more than 28% of your income, for lenders to feel comfortable.
- Credit Score – Your credit score generally needs to be higher to get a favorable interest rate for a second home, probably 25-50 points above the acceptance level for a primary home purchase.
- Required Down Payment – Second homes and/or vacation homes may require a higher down payment level, depending on your lender. If you do not have sufficient cash on hand, you may be able to use equity in your first home, or try an alternate method such as borrowing against a life insurance policy.
- Stability of Income– If you are assuming a second mortgage payment, this will be given even greater scrutiny – especially if you are putting in a lower down payment or using one of the down payment methods above. You may be required to verify a certain number of payments are available as a cash reserve.
It varies according to the market conditions and local factors, but often the interest rate on the loan for a vacation home is ¼ - ½% higher than if it were a primary residence, due to the collective risks listed above.
If it is a stretch to acquire financing, you may want to consider alternate financing, such as going in together with others on purchasing a vacation home – although you will need to be very clear about ownership and specifics of payments and access. If you pursue this route, make sure to have the rules among owners covered with legal documents. You may also wish to consider a time-share investment as an alternative to your own vacation home.
It is not a sure thing to get a mortgage on a second home – but with some planning and diligence, that beachfront property or mountain cabin can be yours. Enjoy!