Guide to Buying a Second Home
How to calculate the costs of buying your new home away from home.
Many people have dreamed of buying a second house, an idyllic retreat where they can commune with nature, create a family haven, or simply get a change of scenery from everyday life. The vacation home you buy today may be tomorrow’s full-time residence once you retire, or a long-term investment that enhances your family’s net worth. In the meantime, you might earn some extra income and defray the cost of a second home by renting it out part of the year.
The COVID-19 pandemic made second-home ownership a necessity for some who fled urban areas and opted to set up rural home offices when commuting to work was no longer a necessity. Vacation home sales were up 57.2% year-over-year in the first four months of 2021, the last period for which statistics were available, according to the National Association of Realtors. Second-home sales far outpaced total existing home sales, which grew 20% in the same period.
Buying a vacation home involves considerations beyond whether you can afford to pay a second mortgage every month. There can be substantial costs to maintaining a second home, stricter criteria for obtaining a mortgage, and concerns that being a homeowner twice over may derail your long-term savings goals, such as building a retirement fund. Here is a second home buying guide that shows how to calculate whether this is the right time for you to start vacation-home shopping.
Will You Qualify for a Loan?
The requirements to qualify for a vacation home loan tend to be more stringent than a mortgage on a primary residence for most people because lenders view a second residence as a slightly greater risk. For example, the down payment for a second home is typically at least 10% of the purchase price, compared with the 5% or less some borrowers are able to arrange for a primary residence. If an applicant has a low credit score or a high debt-to-income ratio (the amount of your monthly debts relative to your monthly income), the required down payment may be 20% or more.
The borrower may also have to show they have cash reserves to pay at least two months of their monthly mortgage payment on both their primary and second homes. If the mortgage applicant is self-employed, they may need to show that they have up to six months of reserves. The more cash reserves borrowers have available, the more lenient a lender may be about a lower credit score or higher debt-to-income ratio when they apply for a second-home mortgage.
Interest rates on second-home mortgages are only slightly higher than on mortgages for a primary residence. Fifth Third Bank offers a variety of mortgages to suit a variety of needs.
If buyers are considering renting out their vacation home, they should talk to their lender about the number of days they will be allowed to have paying guests or tenants. To qualify for a second-home mortgage, borrowers may be expected to live in the property for a certain length of time each year. If they are buying a second home primarily as a rental property, they may have to apply for a different kind of mortgage that can entail a higher interest rate and stricter requirements for a down payment and credit score.
Renting out a second home within allowable limits can help defray the costs of owning the property. But rental income may not be taken into account when determining whether a borrower qualifies for a mortgage for a second home. Nor should the buyer count on income from paying guests to meet their monthly budget. View any rental income as a bonus, not a necessity.
Down Payment Options
One possible way to gather the down payment for a second home is to use the equity from your primary home. If your first home has appreciated in value, you might consider a cash-out refinance, which involves taking out a larger loan on your primary home and using the cash from your original mortgage as a down payment on your second home. If you don’t want to refinance, consider a home equity line of credit (HELOC), which may allow you to tap 85% or more of your home’s equity to buy a second home outright or to use for the down payment.
Tax Breaks on a Second Home
Just like with your primary residence, you can deduct the interest on the mortgage of your second home on your taxes, provided the total of both your primary- and second-home mortgages do not exceed $750,000. State and property taxes are also deductible up to a maximum of $10,000 per tax return.
If you rent out your vacation home fewer than 15 days per year, you don’t have to report the rental income to the IRS. More than that, you’ll pay taxes on the income, but you can also deduct certain rental costs.
Calculating the Upkeep Costs
A vacation house comes with all the costs of maintaining your primary residence—and possibly more if you have to hire someone to take care of the property when you aren’t there. Some of the costs involved include:
- To make your second home a comfortable place to stay, plan on investing in furniture, linens, garden tools, and paying to equip a kitchen. If you plan to occasionally rent out your place, you may need to replace furnishings more often due to wear and tear.
- You may want to invest in a security system for peace of mind.
- You will likely need to pay someone to do maintenance, such as cutting the grass, shoveling snow, and putting up shutters in advance of a storm.
- Your lender may require that you buy flood insurance if your vacation home is in an area where there is a danger of flooding. You will also need homeowner’s insurance.
- Consider the travel costs between your primary home and your vacation home. If you will be flying, you should consider whether you will need another car, truck, or boat to keep at your vacation property. Another consideration is the expense of traveling to your second home.
- You may need to pay homeowners’ or condo association fees. If you intend to rent the property when you aren’t there, check the bylaws for rules that might prohibit renters or restrict them from using the pool or the gym.
Are Your Savings on Track?
Financial experts advise that you not consider purchasing a second home until you are putting away at least 15% of your annual income in a retirement fund, that your separate emergency fund contains at least six months or more of living expenses should you lose your job, and that you have manageable credit card debt.
When to Buy a Second Home
Avoid buying a vacation home during peak season, whether that means ski season for a mountain chalet or summer for a cottage at the shore. Sellers may be more willing to bargain on price if they have to absorb the costs of locking up their properties during the off-season. Between Labor Day and Thanksgiving is a good time to consider purchasing a summer home, while spring can be ideal for a winter vacation home. Another good time to consider buying is right before the busy season, when some sellers might want to avoid competing with a high inventory of vacation homes for sale during the high season.