Buying a second home comes with both major benefits and stricter financial requirements than your first home purchase. Before you dive headfirst into another house hunt, you need to understand the cost of financing the purchase of another home and maintaining the property. For most, that means qualifying for a second mortgage.
In this blog, we’ll cover the big financial differences between making your second home a vacation or investment property, typical mortgage qualifying standards, additional costs, and tax implications.
What’s the purpose of your second property?
So, are you looking to buy a vacation home or an investment property you can rent out for additional income?
Although the question seems like a simple one, the answer critically affects your finances of the purchase. You will need to know the specific use of the home right away when you apply for your mortgage. If you need to rent out the home to afford it, consider this an investment property.
The insurance, taxes, down payment, and mortgage rate all hinge on your second home’s purpose. In most situations, a rental or investment property will require a larger down payment and higher interest rate than a vacation home as well as additional insurance.
Also, if you’re looking into an investment property, you will want to take an in-depth review of the home’s location, local economy, property taxes, and potential resale value of the home.
Mortgage approval requirements change with a second home.
Since this isn’t your first time around, you’ll be familiar with the mortgage process. However, your second mortgage will have tighter restraints than your primary residence.
You won’t be able to qualify for a government-backed mortgage (FHA and VA) on a second home. Instead, you’ll need to qualify for a conventional mortgage. As a result, you’ll need a larger down payment and a better credit score. Here are some of the typical requirements for qualifying for a second mortgage with a conventional loan:
- Expect to make a 20% down payment. However, the range can fall in-between 10-30%. The down payment will be greater for rental properties.
- You will need at least a 620 credit score or higher.
- Your debt-to-income ratio (DTI) will need to be approximately 36-43% of your monthly pre-tax income.
- Interest rates vary depending on the market, but the rate will be higher than your primary residence and even higher if it’s a rental property.
Like any mortgage, stable income and additional money in the bank are essential. The larger the down payment you make and the better your credit score, the lower your interest rate will be. The mortgage financing will be calculated on top of any mortgage debt you have on your primary residence.
You’ll need extra cash on hand.
Many homeowners don’t factor in the financial cost of maintaining their second property. In addition to money for your down payment, closing costs, and monthly payment, you must also have cash on hand for insurance, maintenance, repairs, and taxes. As a rule of thumb, you will want at least six months worth of cash in the bank to cover those basic payments as well as unexpected repairs.
Some properties such as condos or townhomes have HOA fees to cover the majority of the upkeep. Single-family homes require you to be responsible for repairs and property management - especially if you’re the landlord.
Depending on the type of property you intend to own, you may need additional insurance. For rentals, liability insurance is required on top of your typical homeowners and title insurance. You may also need hazard insurance if you buy a property near the water.
In order to come up with some of the additional funds, we sometimes see buyers utilize a cash-out refinance. If this is something you’re interested in, use the chat in the right-hand side of the screen and talk with one of our mortgage experts.
New tax implications come with the second property.
As you might expect, the tax implications of a second home heavily depend on the use and type of property you purchase.
If you plan on renting out the property, you will be responsible for paying an income tax. Many times, borrowers will buy a vacation property and rent it out for part of the year to create supplemental income. The number of days you spend at the property yourself will make a difference in much much you’ll owe in income tax.
The good news is that you’ll be able to deduct interest, taxes, and insurance against the rental property’s income. You can deduct up to $10,000 of your second home’s property taxes per year.
You’ll want to speak with a tax professional before you begin your purchase process. The location and property type can make this part of the purchase vary quite a bit from situation to situation. When you’re paying taxes on two properties, you need to make sure the numbers make sense.
Be smart - run the numbers and talk to professionals.
Since this is a more complicated purchase than your first home, you should always let the professionals handle the heavy lifting for you.
If you’re in the early stages, run some potential numbers with our free mortgage calculator. This will provide you with a good base of what your numbers will look like. In addition, talking with one of our loan officers and laying out your financial situation will allow them to recommend specific financial solutions and mortgage programs that are in your best interest. They will also likely point you in the direction of a financial advisor and other professionals who can weigh in on your situation. You can reach out to us at 855-610-1112 or firstname.lastname@example.org.