There are a variety of reasons why you might consider buying a second home. It can be a sound investment or a relaxing vacation spot. Whether you have a place in mind or are just starting to search the market, you will need to know how to buy a second home.
The actual home buying process follows the same steps. The main concerns with a second home are ensuring that it will be put to good use and that it fits your budget. This guide will help you navigate the process and answer any questions you may have.
Finding a second home
The first thing you will have to decide on is why and where you are going to purchase a new property. Start with your why first. It will help you then decide on where if you are uncertain to begin with.
For instance, if you want to buy a house for a vacation and rental spot, you probably will not look at houses right down the street from your current home. You will likely look for property at a favorite vacation destination of yours, such as a lake, beach, or city.
Why are you going to buy?
For some, this answer might be obvious. Perhaps you frequent a vacation spot and think about how nice it would be to have your own place there to escape to more often.
For others, however, the answer might not be so clear. Here are some of the most popular reasons to look into buying a second home:
- As a vacation spot - Perhaps you want to spend your winters in warmer weather or just have a place to get out of town for the weekend. You might even consider renting the home out the rest of the time to other vacation goers. In some popular locations, rental income from a property can essentially pay all the bills.
- Investment - Real estate is a popular investment option. If you do not plan on living at the property, you can look into long term rentals, 6- to 12-month periods.
- A retirement home - A popular option for older individuals and couples is the purchase of a retirement home. Perhaps the ideal home has become available a few years before your retirement. You can purchase now and have it ready for you upon retirement. It can even be used as a rental property in the meantime.
- Fix and flip - Another investment strategy is to purchase older or damaged homes, fix them up, and flip them for profit. This demands more time and money, but it’s a popular option as well.
- Work - Maybe your job demands that you spend a lot of time in two locations. Buying a second home in the second location can save you the time, money, and headache that comes with always trying to find a place to stay.
- Just want a second home - Perhaps you don’t have a reason, and you just want to buy a second home. You can decide to flip it, rent it, or move in later.
Where are you going to buy?
Answering the question of why you are going to buy a second home leads you to also consider where you are going to buy. If you have a vacation spot or retirement location in mind, then you are pretty set.
You have a few more options if you are considering a rental or another investment property. You might consider purchasing a place at a popular vacationing location such as a beach, a lake, or a lively city. Or you may want something local so that you can keep your eyes on it. Or, you may want to take advantage of all those college students looking for places to live every year.
Each location has pros and cons. You might consider talking with local real estate agents who know the area better or reviewing different sites for further information if you are considering entering an unfamiliar market.
Can you afford a second home?
Okay, now that all the excitement has worn off, it is time to get serious. Can you afford a second home? Sure it might sound like a great idea, but do you have the money, or can you get the money to purchase a second home and stay out of financial trouble?
Even if you plan to rent out the property, you need to make sure you can afford the upfront costs as well as other monthly costs if you are unable to find tenants immediately.
Mortgage for a second home
Securing a mortgage for a second home is not as easy as it may have been for your first. The requirements for a second home mortgage are more strict.
One thing most lenders are going to consider before offering you a loan is your debt-to-income ratio. Debt-to-income is a comparison between how much debt you have and your income. Debt includes any monthly recurring payments. These include credit cards, other mortgages, car loans, leases, and student loans. Your income is how much money you are bringing in monthly.
If you have a monthly income of $4000 and pay $1200 against debt, then your debt-to-income ratio is 30% (1200/4000 = 0.3). The lower this number, the better. Lenders typically will not offer a second mortgage unless your debt-to-income ratio is below 43%. Other lenders are more strict and look for ratios closer to 36%.
If your ratio is below 36%, you will likely have no problem getting a mortgage for your second home. If your ratio is somewhere between those two numbers, you may have to shop around a bit to find a lender who will work with you. If your ratio is above those numbers, especially if it is significantly above it, you should work on lowering the ratio before purchasing a second home or seeking alternative funding options.
Because you cannot qualify for loans from the Federal Housing Administration or Department of Veterans Affairs on a second home, it will be difficult to find low or no down payment options. Most lenders are going to require a minimum 20% down payment to receive a mortgage.
The lender may require a 30% or higher down payment if you plan on renting the property out. This is because of the uncertainty in the rental market. You may struggle to find tenants at some point, and the lender needs to know their investment will be safe.
If your debt-to-income ratio is significantly high, you may be able to receive a mortgage if you can afford to make a higher down payment. For instance, if you have a ratio of 55% but you can afford a 50% down payment, there may be lenders who are willing to work with you because you may qualify for lower rates and cheaper premiums.
Most creditors will also expect a high credit score to qualify for a mortgage on a second home. They often require a credit score of 720 or higher.
Second home mortgage rates
Exact mortgage rates will vary with the market, but you should expect to pay a slightly above market rate for your second home. If the 30-year fixed rate is 3.4%, you might see rates for second homes closer to 3.7%, or higher.
Your exact rate will vary based on other factors as well. These include your financial state, the size of the down payment, terms of the loan, property type, and location.
Even if you do qualify for a mortgage for your second home, you should still review your budget to make sure the purchase makes sense. It is essential to know all of the costs going in. These include taxes, maintenance, homeowners or condo owners association fees, furnishing costs, landscaping, and insurance.
You may intend for your property to pay for itself with rental income, or at least help ease the monthly costs. But what if you can not find tenants right away and have to go a few months making the payments yourself? Can you afford that?
These are questions you should consider before going in. Assessing your financial situation and talking with a financial advisor might offer a clearer idea of your options. At the very least, if you cannot afford a second home right now, you can develop a new financial plan that allows you to purchase one in the future.
You can seek alternative funding sources if you are committed to purchasing your second home now but will not qualify for a second mortgage. You might consider joint-mortgage or loan options from friends or family. Each of these comes with their own risks and should be assessed seriously before going with them instead.
In either case, buying a second home can be a fun and exciting venture. It can also be a dangerous one if you are diving in headfirst. It is best to test the water, assess your funding options, and your financial situation to ensure success with your second home.