Buying a second home? Know the extra costs and requirements
Financing second homes
- Lenders view mortgages on second homes as more risky than primary-residence loans.
- It is easier and less expensive to get a mortgage on a true second home or vacation property than on an investment property.
- If the borrower collects rent on a property, then the property is classified as an investment property.
It is possible to obtain a mortgage to purchase or refinance a second property, but this loan is likely to have higher costs than your primary-residence mortgage.
Lenders view loans used to buy second homes as riskier, and typically charge a higher interest rate. The lender assumes you are more likely to pay the mortgage on your primary home than on a second home should you run into financial trouble. It gets even trickier to get a mortgage if you plan to rent out the property.
Before going any further, it is important to establish that there is a difference between investment properties and a true second home, which is typically a vacation property. It is generally easier and less expensive to get a loan for a vacation property or second home that you plan to visit and occupy at least for a portion of the year. A second home or vacation property typically carries a lower interest rate than an investment property, and lenders may require a lower down payment.
Vacation homes vs. investments
To qualify as a second home, the home typically has to be in a traditional vacation area or be located with a reasonable distance from the borrower’s primary home— 50 miles from the primary home is the rule of thumb most often quoted by mortgage professionals. The borrower must use the property exclusively for the family’s own use. Timeshare properties do not qualify.
Generally, if you are earning income on the property, you cannot claim the property as a second home, and lenders consider it an investment property.
Borrowers pay a higher rate for a property that they are renting, and generally have to put down more money to obtain the loan. A down payment of at least 25 percent is typical, according to mortgage experts, but lenders may require that you hold an even higher stake in the home.
Fannie Mae and Freddie Mac, which purchase loans from lenders and securitize the mortgages, use risk-adjusted pricing that adds a surcharge to an investment property. The charge will depend on the borrower’s credit score and the extent of the down payment. On average, the interest rate on an investment property loan will be 1 percent higher than the standard rate for a primary residence.
Higher lending standards
Borrowers also have to jump through more hoops to obtain a mortgage on an investment property. Typically, they need a high credit score and have reserves in the bank equaling up to six months of mortgage payments. The application involves many of the same steps of applying for a mortgage on a primary home.
If you’re a borrower, expect to establish your creditworthiness and ability to repay the mortgage. You will be asked to produce income statements, rental agreements and tax returns that establish the rental income. In addition to investigating your credit history, the lenders want to establish if the investment is a good one and supported by the rents.
The bottom line is that a mortgage on a second home can take on some of the complexity of commercial mortgages. Borrowers can expect to pay a higher price for the mortgage and do more work to prove your creditworthiness. One last thing to mention about investment properties is that not all lenders offer the same loan terms. So, shop around to find the best deal.