Property is generally a smart long-term investment, and adding a second home can give you a valuable appreciating asset with many practical advantages. Let’s take a look at how to buy a second home and consider some important factors you should keep in mind along the way.
Double Doors: What Goes Into Buying a Second Home?
Whether you’re eyeing a lake house getaway with a dock for your powerboat or thinking about a fixer-upper, a second home can be a smart step up the property ladder.
Second homes have been investment options with enduring appeal. In 2020, the National Association of Home Builders estimated that there were about 7.5 million second homes in the U.S., which is about 5.5% of the housing market. Indications are that the number grew because more people sought housing outside of cities in the wake of the pandemic.
That said, the federal government’s recent increase in interest rates has had a negative effect on current home prices—making the housing market very different from in 2020. With mortgage rates double what they were at the beginning of this year, home sales have been slowing down considerably as potential buyers decide to wait and see how it all plays out.
Why a Second Home?
People commonly seek a second home for one or more of the following purposes:
As a vacation destination, such as a cabin, condo, or beach house
As an investment property that can be renovated and resold or held as an asset
As a secondary residence used part of the time
In many cases, people will seek to rent out second properties either as a primary source of income or to offset the cost of owning the property. Whatever the purpose, a second property is a valuable fixed asset that can be used today and rented or sold later to yield income for college, travel, or retirement.
Buying a Second Home
Purchasing a second home is naturally very similar to buying your first property, but there are some significant differences related to how your property will be used and financed.
Do Your “Home” Work
Can you afford a second home? As with your first home, you’ll need to do your due diligence. Your existing home is your financial anchor, and purchasing your second home must not affect your ability to continue paying down and building equity in your primary residence.
In addition to the one-time costs of buying your second home, you will need to be sure you can absorb the additional monthly payments for your second mortgage. Of course, if you’re looking at a basic weekend retreat or a vacation condo, you might be paying much less than for your actual residence, but you should not consider a second home for personal use unless:
You have significantly increased your income.
You have started to build significant equity in your existing home.
Second Home or Investment Home?
Buying a second home that you’ll use as a primary source of income is, however, a different matter. If you’re planning to set yourself up as a landlord, then you need to be sure that you can cover the acquisition costs for the property out-of-pocket and that the rental income will cover enough of your monthly payments to make the investment sustainable.
You will also not have as much discretion about when and how you maintain your property. So you’ll need to have funds readily accessible to take care of standard property maintenance plus any emergency issues your tenants might encounter.
Getting Financing
However you plan to use your property, you’ll need to satisfy the requirements of your lender in order to qualify for your mortgage. You’ll need to show evidence of:
A steady income
Sustainable spending
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Limited liability
In particular, you’ll once again have to show that your debt-to-income ratio (the amount you owe in proportion to what you earn) isn’t too high, and you'll, of course, be limited by your existing commitments.
While most lenders will be wary of extending credit for a first mortgage where your payments will exceed 35 percent of your total income, to qualify for a second mortgage you will most likely need to demonstrate that your total debt commitments do not exceed 43 percent of your total income.
Down Payment
As with your first purchase, finding ready cash for a down payment is crucial. The more money you can put down upfront, the lower the rate and the better the terms your lender will extend.
Lenders consider the likelihood you will default on your mortgage payments to be higher with a second property because you won’t risk losing your home. As a result, they generally require more money down than with an initial mortgage. Expect to put at least 10 percent down, even with excellent credit.
Government-Backed Financing
Access to government-backed low or zero-down loans, such as those guaranteed by the FHA, USDA, and VA, or by local or state bodies, is limited if you’re not buying a primary residence. In particular, VA loans have complex rules about entitlements, but in most cases, they won’t back a loan for a property where you won’t be living full-time.
Borrowing to Buy
If you do have significant equity in an existing property, you might be tempted to take out a home equity loan to supplement a down payment on a second property. While reinvesting an equity loan in property you own is a good idea, even if interest rates are low and property values rise, it can be a risky move.
You should be absolutely sure you’ll be able to pay down both your mortgages plus continue to make repayments on your home equity loan. Failure to make any of these commitments could jeopardize your most valuable asset—your original home.
Loan Rates
When you seek approval, and of course when it comes to buying down points and locking in a loan, you’ll typically find that your interest rates are higher than for your initial loan. This again reflects the fact that your lender considers you a higher default risk on your second mortgage because of your other commitments and because your original home is not at risk.
Home Run
Aside from these considerations, buying a second property is going to look very similar to buying your first home, including:
Getting pre-approved for financing
Finding a property and negotiating a deal
Signing a sale agreement with contingencies
Carrying out inspections
Locking in your rate and closing on your sale
Expenses such as closing costs and other fees
Taxing Issues
Whether your new property is a home you and your family will use, an investment that will build wealth, or both, it is up to you to make the most of it. For instance, if you intend to rent out your property—even occasionally for short-term rentals—and want to write off your mortgage and maintenance costs as a business expense, tax regulations will govern how much time you can use the property for your personal use.
Build Your Property Portfolio With Listerhill
It might not be your first time around the block when it comes to property ownership, but working with Listerhill to finance your second home comes with clear advantages.
As a locally based community credit union, we offer our members:
Financing available up to 100% on certain mortgage products
Adjustable and fixed-rate loans
Construction loans
No administration or mortgage tax fees
No monthly charge for mortgage insurance with our In-House Loan
Stability as an Equal Housing Lender
Buying a second home is a big commitment with big rewards. Listerhill can help make it a reality.
Learn more about buying a second home.
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