Getting a mortgage on a second home or vacation property.
Buying a home is one of the biggest investments most people will make during their lifetime. It is typically seen as one of the ‘rites of financial passages’ for many people. After all, it helps you avoid having to pay rent to someone else, just so they can use it to pay their mortgage. Instead, it allows you to use those funds to build your own equity.
But what about buying a second home? Like a vacation home, for example. Is that a good investment to make? The truth is, there is no set answer to that question. Ultimately it depends on your financial health, your personal preferences, and your financial goals. Here are some things to think about and some recommendations for getting your second home / vacation property mortgage.
Having some cash saved is a good idea.
Having a higher than normal credit score is recommended.
To finance your second home, you can use a a cash-out refinance or a home equity line of credit on your current home or get a conventional loan on the new property.
You can potentially use any rental income to help pay for your new property.
Keep in mind that second home mortgages often have a lower rate than mortgages on vacation properties.
Aside from what it takes to get the mortgage on your second property, there are several other factors to consider before making a new purchase. Below are 5 of the key things that should be considered before making the leap to purchasing a second home.
Thinking about buying a second home or vacation? Here are 5 of the top things you should be considering.
One of the most important things to consider when buying any type of property is the location. Have you ever heard people say, “Location, location, location!” when thinking about buying a property? Well, they aren’t wrong. The location is perhaps the most important consideration because it will not only dictate how satisfied you are with the purchase, but it can also dictate how valuable the home is and/or becomes.
If you are buying a second home strictly to use for vacations, you want to be certain that the home is located in a good vacation spot. You want to consider the climate and everything about the location to find the right one.
Are you looking for a vacation spot that is serene and peaceful? If so, you might want to look at cabins in the woods. If you’re someone who would much rather spend your days on the beach, you may be more tempted to consider a condo at your favorite beach. Maybe you want the beach but without the interruption of spring breakers or other tourists; which might make you lean towards an exotic location, like Costa Rica.
You should also consider the location for investment reasons. Figure out how much the property was worth in the past, look at future plans for development, and consider whether or not there is a good chance of the property appreciating. No one wants to purchase a property only to find out that they purchased it at the height of its curve and then watch as property loses value over the next few years. While the timing might be difficult to predict, you should be able to look at all of the factors to make a well-educated decision. Speaking with a local real estate agent can clue you into a lot of details that will help you make a more informed decision.
Typically, vacation homes are situated in desirable places where people are looking to visit and spend time. These vacation areas are typically more prone to experiencing market appreciation because there is so much demand for them. That being said, you still need to be cognizant while investing. The values you see can vary to each extreme even in some of the areas that are considered ‘hot spots.’ After all, these areas might be located in hurricane zones which can completely wipe-out and devastate the local economy to the point it cannot recover for a long time.
The truth is, you have so many options that you can choose from, they seem almost limitless. Whether you want a waterfront bungalow that oversees the bay or a secluded, wooded property on a beautiful lake, you should be able to find something that is worthwhile. No matter the destination you choose, it may be helpful if you spend a good amount of time in that area before buying a second home there. The location must be right for you.
You also need to factor in all the costs, because you need to figure out whether or not you can even afford it. Even if you are able to afford it, are you ready to put other things that you may want on the back burner to purchase a second home? Real estate is something that is a very long term decision that can have long term implications that you have to consider. The transaction costs are very high for buying and selling property. Therefore, you cannot simply sell your new home a month later and recover all of the costs associated with the purchase. Property isn’t a liquid asset that you can simply move on from quickly. It can take a lot of time to sell.
Therefore, you want to figure out the price of a second home you can realistically afford and find one that is available within that range. You will need to carefully calculate all of the costs associated with buying. Including the normal maintenance costs, the annual taxes on the property, insurance coverage, and more.
You want to consider the fact that you are going to have added costs associated with your property because it will be your second property. Vacation homes will have various things to consider on top of your normal costs. These may include, but not limited to, property management fees, activity fees, liability insurance, and potentially more depending on the property itself and its location. For example, if you get a place that has a pool, you will need to factor in pool costs and you will also need to consider the cost for winterization and even flood or hurricane insurance expenses. Even something as mundane as traveling expenses should be factored in if you are buying a place to vacation throughout the year.
For instance, I have friends that have their own vacation house on Little Cayman. The house is extremely nice, but it is exorbitantly expensive to travel to. Because it’s on an island, everything there is much more expensive. However, as long as you plan and budget for these additional costs prior to purchasing a vacation home, you will be able to do so without any surprises. You want to feel the security knowing that you can afford your second home.
If you don’t have the cash flow needed to simply purchase the second house outright (and the average person does not) you will need to get a mortgage for it.
First, you should see whether or not you qualify. This will depend on your debt-to-income ratio. The lender will factor in how much you owe in relation to the total income you are bringing in. A lot of mortgage programs are not going to offer you a mortgage if your total debt exceeds anywhere near 45% of your income.
To get a good estimate on whether or not you will be put over the limit by getting a second mortgage, you should be factoring in your current mortgage payment. Then, you want to add the second mortgage payment and simply divide that number by the amount you are bringing in prior to taxes.
For example, if you are currently paying $1,800 in mortgage payments and your second home mortgage payment is $1,500 and your annual income is $90,000 you would have a 44 percent debt-to-income ratio. This is likely to be too significant for most lenders who are looking to reduce risk.
The good news is, you generally don’t need to make a huge down payment in order to get a second home. You should be expecting anywhere around 10% on a second home or a property you will be using for vacations unless you are getting a jumbo loan. If you are taking out a loan greater than $510,400 after the initial down payment, you should expect to pay more around 20%. Prior to beginning the process of looking at different properties based on their price range, you want to ensure that you have the funds needed to cover the down payment.
There are several more considerations you could make for your mortgage. You will need to have a good credit score if you want to be able to qualify for another mortgage. Typically, you need a minimum of a 680 credit score to even be considered. Luckily, the interest rates that you will be getting on your second mortgage will typically only be a small percentage higher than your primary mortgage.
One of the biggest things that make people want to purchase either a second home or a vacation property is to be able to have more freedom with their lifestyle. A lot of people even make the choice to retire in the second home which can really help make the investment worth it. However, it does open up a lot more things that you should be thinking about such as access to health care and more. After all, that remote home that you want in the hills of Panama might not necessarily have the urgent medical care you may require when you are in your 70’s.
5. Rental Income
One of the best ways to offset a lot of the costs associated with buying a second home is by renting it out. You can do this whether you opt to rent it out short term or long term. If you are purchasing the home as your retirement home and you won’t be retiring for a while, you could always rent it out long term to help pay for the mortgage.
Keep in mind though, you will need to pay more in maintenance and other related costs for a vacation rental home over a traditional rental home. Likewise, if you have a vacation property, you have to factor in the off-season where you will likely have vacancies.
Buying either a second home or a vacation home can be a major financial decision. It is one that you want to take seriously and you should do your due diligence prior to making it. Like any other investment, you want to do the necessary research to be certain your investment is a good one. By taking your time, doing your research, and being patient, you should be able to acquire the best property for your needs.
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