Financing the Purchase of a Second Home
Thinking about buying a second home? If you've been fortunate enough to come through the economic downturn relatively unscathed, you can get some real bargains on vacation properties these days. But getting a mortgage may be a challenge, even if your own finances are in good order.
The downturn in the real estate market has created some great deals on vacation properties, with some of the biggest price drops in popular destination states such as California, Florida, Arizona and Michigan. In some areas, prices are down by as much as one-third to one-half from a few years ago.
Best bargains may be hard to finance
However, these same price drops have made lenders wary of issuing mortgages in these areas, particularly on second homes, which are seen as a riskier investment than a primary residence. As a result, you'll need to bring more money to the table and have better credit than would have been previously required.
It used to be that you could buy a second home with as little as 20-25 percent down, but many lenders currently require as much as 35 percent, particularly in high-risk areas or for nonconforming "jumbo" loans. In some cases, you may still be able to find a lender willing to offer a vacation home mortgage with less than 20 percent down, but you'll need to pay for private mortgage insurance and forget about it if you're looking to buy in places like California, Florida or Michigan.
Vacation home or investment property?
One of the key things you need to decide is if you're going to buy the property as a second home or an investment property. There are advantages and disadvantages to each, and you can still use the property as a vacation home in either instance.
Many second home buyers count on renting out the property at least part of the year to help defray the cost of ownership. While that can be a good strategy, it may require that you purchase it as an investment property. On an investment property, you'll typically pay a higher interest rate than you would on a second home. You also won't be able to deduct the mortgage interest on your income taxes, as you can often do with a second home.
For an investment mortgage, the lender will likely insist on seeing past rental records for the property. If the home hasn't been rented out before, you may be able to draw upon rental histories for other properties in the same development. Your lender will probably assume about a 25 percent annual vacancy rate, higher if you're buying in seasonal areas, so take that into account when figuring the rent you propose to charge.
Renting out your second home
If you purchase the property as a second home, you may still be able to rent it out occasionally, although the lender may insist that it be reserved for your exclusive use for part of the year. The interest rate will be slightly higher than you'd pay on a primary residence mortgage, but still less than on an investment property, and your loan origination fees will be about one-quarter to one-half of a percentage point higher than you'd pay on a mortgage for a primary residence.
Finally, be aware that you may have a difficult time obtaining financing if you're thinking about buying a condominium as a second home. Many condominiums in vacation areas are primarily used as rental properties, and lenders typically won't touch a mortgage in a condominium project that's more than 30 percent rentals these days, particularly in a vacation community. In that event, your only option may be to approach it as an investment property.
You also want to be sure to check out any tax implications for your particular situation, so be sure to consult with your tax advisor before committing to any second home purchase.