Buying a second home: what to do and how much does it cost

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Buying a second home has become a popular option for some Americans, and it’s easy to see why. Second homes can serve as a private getaway, source of rental income, or retirement for friends and family.

And, with increased possibilities to work remotely, you can even use a second home as a living space whenever you need a change of scenery or more space.

Learn more about the pros and cons of a second home and what goes into buying one:

How to use your second home

There are certain financial implications depending on how you plan to use your second home.

As a holiday home

Owning a vacation home means you’ll always have a place to stay when you visit your favorite spot outside of town.

You can make sure it has everything you need to be perfectly comfortable, and keeping an extra set of clothes and toiletries in your second home means minimal packing when you want to get away from it all. .

As for the financial implications, some expenses associated with owning a vacation home could be tax deductible. Mortgage interest is deductible under the same rules as a primary residence as long as you do not rent the property.

Advice: If you rent the property you can still benefit from a mortgage interest deduction. You would just have to use the house for more than 14 days or more than 10% of the number of rental days, whichever is longer.

You can usually deduct local and provincial property taxes as well, subject to the usual rules capping this deduction at $ 10,000. These deductions will only save you money if you itemize.

Read on: How to buy a house: step by step guide

As a rental property

If you want to buy a second home to be used primarily as a rental property, lenders and the IRS will classify it as investment property.

Owning a rental property can have a number of advantages. It acts as a passive source of income and allows you to take tax deductions which can offset the costs of ownership.

Advice: The tax implications of owning rental property are different from those of primary residences or vacation homes. For example, you can write off the property and deduct the rental costs from the rental income to reduce your tax liability.

Here are some of the rental costs that owners of investment properties are allowed to deduct:

  • Publicity
  • Cleaning
  • Maintenance
  • Insurance
  • Mortgage interest
  • Management fees
  • Utilities

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Advantages and disadvantages of a second home

A second home can provide convenience, enjoyment and income, but it will also come with additional expenses and responsibilities.

Benefits

  • You can use it as an investment. Whether you rent it out for a few days a year or as a full-time investment property, a second home can be an additional source of passive income. If the property appreciates significantly, you can also sell it for a profit later.
  • You could benefit from tax relief. If you pay mortgage interest and property taxes on both your primary residence and vacation home, you are more likely to benefit from itemized deductions on your tax return. Investment properties also have tax advantages similar to those of the management of any other business.
  • This can simplify your vacation planning process. If you like to visit the same destination frequently, you might appreciate not having to book a place to stay every time you travel.
  • You can retire there later. If you know you want to retire somewhere else, buying a second home there now can give you a head start and ease your transition down the road.

The inconvenients

  • No investment is a sure thing. Make sure your finances are strong enough to withstand long-term second home ownership, especially if the rental or resale markets weaken.
  • You will have to bear additional costs. If you don’t pay cash, there are borrowing costs for a second home. You will also have to incur maintenance costs and property taxes. Also expect to pay higher insurance premiums than for a primary residence.
  • You will need to manage the occupancy rules. Lenders, local laws, and homeowner’s associations may restrict how you can use your property, including how often you can rent it and how long each rental term is.
  • You will have less money for other things. You might be tired of vacationing in your second home, but you have so much money tied up that you can’t afford to travel anywhere else. Maintaining a second home can also compromise your ability to meet other financial goals, such as saving for retirement.

Qualify for a second home

If you take a mortgage loan for your second good, know that the interest rates and qualification standards are higher than those of a principal residence.

Your interest rate will be 0.25% higher on a vacation home if you deposit less than 15%. On an investment house, the rate will be 2.125% to 4.125% higher. The more your advance payment, the lower the tariff premium.

Here are the lender requirements for second home purchases as set out by Fannie Mae and Freddie Mac:

Vacation home Investment house
Min. credit score 680 680
Maximum debt ratio 45% 45%
Min. advance payment ten% 15%
Min. cash reserves Two months Six months
* The above requirements are for single unit properties only.

Credit score: 680

Minimum credit score to buy a second home is 40 points more than the minimum required to qualify for a conventional loan on a primary residence.

Debt-to-income ratio: 45%

The maximum debt to income ratio to buy a second home is 45%. With this DTI, you will likely need compensating factors like more months of cash reserves, a larger down payment, or a higher credit rating to buy a second home.

Keep in mind: If you keep paying off your first mortgage, it can be difficult to achieve a debt-to-income ratio low enough to qualify for a second mortgage.

Deposit: 10% to 15%

The minimum deposit on a holiday home is 10%. On an investment house, it’s 15%.

Reserve payments: value from 2 to 6 months

At a minimum, you’ll need enough money in the bank to cover a few months of principal and interest, risk insurance, property taxes, and, if applicable, homeowner’s association dues.

On a vacation home, lenders require you to have two or 12 months of cash reserves depending on your down payment, credit score, and debt ratio. For an investment property, that is six or 12 months.

Other methods of financing a second home

Getting a mortgage isn’t the only way to finance a second home. If you have enough equity in your first home, you can use it to buy or at least put down a down payment on your second home.

Tap into the equity in your home

Maybe you have already refinanced your primary residence at very low rates and refinancing would again mean paying a lot in closing costs. A home equity loan or Home equity line of credit (HELOC) could allow you to access up to 80% of the equity in your home without affecting your first mortgage rate.

One thing to remember: Home equity loans and HELOCs generally have higher interest rates than first mortgages, but you can use the money however you want.

Use cash refinancing

Cash-out refinancing can be a great way to take advantage of lower interest rates while withdrawing some of your accumulated equity.

For example, if you owe $ 100,000 on your mortgage and your home is worth $ 500,000, you can use cash refinancing to take out $ 300,000 and buy another home.

Since you would then be paying cash for your second home, you wouldn’t be subject to tighter underwriting, higher interest rates, or lender restrictions on how you could use the property.

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About the Author

Amy Fontinelle

Amy Fontinelle is a mortgage and credit card authority and contributor to Credible. His work has been published in Forbes Advisor, The Motley Fool, Investopedia, International Business Times, MassMutual, etc.

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