A Guide to Buying a Second Home or an Investment Property

Vacationing

According to a survey carried out by GOBankingRates, 40% of Americans who partook owned vacation homes. In addition, a large percentage spent less than $200,000, whereas only a small fraction spent $500,000 or more. People who buy second homes for vacationing typically like getting away from the hustle-bustle of their everyday lives once in a while and getting close to nature, be it the mountains, a lake, or a beachfront.

Rental Income

There are two ways to approach renting. If you buy it in a neighborhood that allows short-term rentals, you may rent it out on platforms like Airbnb and VRBO. Alternatively, you may rent it long-term, but in this case, it would become an investment property. In both cases, the rental income can help in paying down your mortgage.

Retirement

Buying a second home before you retire can be beneficial in different ways. For example, you get to spread the cost over a prolonged period and also get to use the second home before retirement. Besides, you may choose to rent your primary or second home depending on which one you use at any point in time.

Tax Benefits

If you purchase a second home for personal use and don’t plan to rent it out, you may deduct the interest you pay toward a mortgage in state and local taxes. However, these depend on the deductions you’re already using toward your first home, and you should contact your financial advisor or accountant for tax advice.

Factors You Need to Consider

All the benefits of purchasing a second home sound wonderful, but there are other important factors to consider.

Financial Implications

If you haven’t paid off your first home’s mortgage completely and plan to get a mortgage for a second home, you’ll need to make two mortgage payments every month. In addition, you’ll need to account for the maintenance costs of two properties. While you might be able to afford these expenses now, make sure you take the long-term picture into account. For example, do you have enough savings and do you need to save for your children’s education?

Financing

For anyone wondering, “Is it harder to get a loan for a second home?” know that this depends on meeting different eligibility criteria. In addition, while first-time homebuyers get to choose from different types of mortgages, second-time homebuyers don’t get as many options. If you wish to buy a second home as an investment, you may consider applying for a second home investment loan. Your other alternatives include:

• Conforming loans. Conforming loans satisfy different terms and conditions set by Freddie Mac, Fannie Mae, and the Federal Housing Finance Agency (FHFA), including region-specific maximum loan limits. These loans tend to come with lower interest rates when compared with non-conforming loans.
• Jumbo Loans. Jumbo loans exceed conforming loan limits, allowing you to borrow considerably large sums. However, you need a credit score of 700 or higher to qualify and make a down payment of 10% to 20%.
• Cash-out refinancing. Cash-out refinancing involves refinancing your existing mortgage, where you get money for some of the equity you’ve built in your house. However, the amount you owe toward your primary mortgage will increase because of the cash-out refinance.
• Home equity loan. A home equity loan does not involve refinancing your existing mortgage. Instead, you get a second loan against the equity you’ve built in your home.

Use of Home

Do you have to put more money down on a second home? This largely depends on how you plan to use the home you purchase. For example, if you use it as an investment, you need to pay at least 20% down payment. In addition, you may expect to pay a higher interest for an investment loan.

To qualify as a second home, you must live in it for some time during the year. While you may offer it for short-term rentals, you need to keep it for your personal use for a minimum duration each year. In addition, it should be at least a predetermined distance away from your existing home. If you’re buying a home to fix and flip or rent out long-term, it will count as an investment property.

Renting

If you plan to use the rental money you get from your second home to pay off your mortgage, pay particular attention to the location you select. If you think that buying a home near a popular tourist destination that commands premium rates might work well for you, bear in mind that most such places have peak and slow seasons. Besides, you might need to forgo your desire to spend time at the home as and when you want.

With short-term renting, you also need to account for state, city, and local zoning regulations. For example, if you buy a second home in New York City, you cannot rent it out entirely for less than 30 days. When it comes to short-term rentals, the city only allows two guests and requires the presence of the primary resident the whole time. The city’s Local Law 18 also requires short-term rental hosts to register with the city.

Short-term rentals can be a concern in neighborhoods with homeowners associations as well as condominiums because many across the country are trying to limit the presence of short-term renters.

If you’re buying an investment property, you may rent it long-term.

Taxes

The Internal Revenue Service (IRS) requires that you stay in your second home for a predetermined minimum number of days each year for it to count as a place of residence. If this is the case, you may deduct the interest you pay toward your mortgage.

If you don’t rent out your second home for a given number of days per year, it counts as a second home. In this case, there’s no need to report the rental income. However, you need to do so if you rent it out for more than the prescribed number of days.

If the IRS views the home as an investment property, you may file deductions related to expenses surrounding operating and maintaining the property. If the amount you spend exceeds the rental income you earn, you may report your losses through Schedule E (Form 1040).

When you sell your second home, whether or not you qualify for capital gains exclusion depends on how much time you have spent in it and the time that has passed since its purchase.

Bear in mind that states have their own tax laws in addition to the IRS. This makes it important to seek tax advice from your financial advisor or accountant.

Ongoing Costs

How much you need to spend toward ongoing costs depends on how you plan to use your second home, and here are some expenses that remain common across the board.

• Insurance. Homeowners insurance tends to cost more on second homes than primary residences. Besides, you might need additional insurance based on whether you plan to use your new home for short- or long-term rentals.
• Maintenance. Maintenance costs can come in the form of major seasonal expenses as well as basic repairs. Even if you don’t reside at the property much and don’t rent it out, you’ll still need to spend some money on its upkeep. While hiring someone to manage the property in your absence is a great idea, you need to account for the costs at the onset.
• Utilities. If you rent the home out, you may get the renter to pay for the utilities. However, if the home remains unoccupied for any duration, you’ll need to keep paying at least the minimum costs to keep the utility connections going. You might also consider investing in a home security system.
• Travel. If you buy a vacation home, you need to account for the costs you will incur in traveling to and from the property.

Second Home Mortgage Requirements

When you apply for a second mortgage, you may expect a lender to look at the same financials such as your down payment, credit score, and debt-to-income (DTI) ratio. What varies is that you have to meet higher standards when getting a mortgage for a second home. This is because lenders feel borrowers with multiple mortgages have more chances of defaulting if they face financial difficulties.

Down Payment

If you’re wondering how to buy a second home with no money, know that it might be possible if you’ve paid off your first mortgage completely and then qualify for a no-down payment mortgage like a USDA loan or a VA loan.

With your first mortgage, you might have paid no down payment at all depending on the one you got. Even with a conventional mortgage, there’s a possibility you might have paid at least 5% of the home’s buying price. However, with a second mortgage, expect to pay at least 10% as down payment, although most lenders look for 20%. The minimum you might need to pay for an investment property is between 15% and 25%.

Credit Score

A majority of lenders require borrowers who apply for second mortgages to have credit scores of at least 620, although some look for scores of 680 and higher. While a good credit score of 670 to 739 increases the likelihood of your application’s approval, a very good score of 740 or higher brings with it an even better possibility of getting the mortgage you seek. If you plan to get a second home investment loan, expect lenders to look for scores of 700 and higher.

DTI Ratio

First-time homebuyers may qualify for mortgages with DTI ratios of up to 43%, although lenders prefer it to be 36% or lower. For a second mortgage, it is important to keep your DTI ratio below 36%. If you wish to use the home as an investment property, it might be possible to include up to 75% of the expected income from rent toward your DTI.

Conclusion

Despite all the work that goes into buying a second home, it can be an exciting and fulfilling process. After all, while it can work as a great investment, it can also provide significant value to your life. Whether you plan to buy a vacation home or an investment property, consider contacting a mortgage provider that offers loans for second homes and getting preapproved. This should give you an indication of how much you may borrow and you can then look for homes accordingly.

You should also discuss your plan of buying a second home with your financial consultant or advisor to determine if it aligns with your existing finances and long-term financial goals.