For many Americans looking to make profitable long-term investments, buying a second home or a vacation home can be a highly attractive option. After all, with property-value appreciation, tax advantages and the potential for added monthly cash flow via property rental all factored in, residential real estate can be among the safest and most lucrative investment options out there. And of course, for those who own vacation properties, the perks can be plentiful when the time to get away from the daily grind comes around.
Are you and your family thinking about purchasing a second home or a vacation home? Before making the leap, it’s a good idea to gain a better understanding of the lending process and particulars for second homes and vacation homes — which can differ significantly from those for rental properties and primary residences (primary home mortgages). Consider these six important things to know about your potential purchase:
- Your first home could help you buy your second: For homeowners who have a large amount of equity in their first home, the situation can provide big advantages when it comes to funding their second. One mortgage option that may be worth considering in these cases is cash-out refinancing, which allows homeowners to access their current home’s equity by replacing their current mortgage with a new, larger mortgage. Others include the home equity loan and home equity line of credit, which use the homeowner’s home equity as collateral for obtaining money via a second loan or line of credit.
- The way the home will be used can have mortgage impacts: How you plan to use your second home can affect how it is classified by the lender — and thereby affect your mortgage on it.
The home can qualify as a vacation or second home (which typically enables a lower down payment and interest rate) if:
– the home belongs only to the buyer
– the owner will live in the home for at least part of the year
– the home is a single unit that can be used throughout the year
– the property is a minimum distance from the owner’s primary residence
– the home will not be rented out over the long term or controlled by a property-management firm
The home is considered an investment property (which typically carries a higher down payment and interest rate) if:
– it is bought solely for renting out or for flipping and selling for a profit
– the property consists of multiple units
Either way, the underwriting process for your second mortgage is likely to bring more challenges than your first one did, including higher interest rates, the requirement for a larger down payment, higher standards for your credit score and debt-to-income ratio, etc. This is mainly because most lenders will assume that, should financial issues arise, most borrowers tend to place a higher priority on keeping up with their primary residence’s mortgage than that of their second home.
- The purchase is also likely to have tax implications: If you intend to rent the property out, whether for shorter-term vacation rentals or to longer-term tenants, the rental income you take in throughout the year will be taxable. On the other hand, as the owner of the property, you may also be able to claim tax deductions for property-related expenses such as repairs, operating expenses, property taxes, mortgage interest and depreciation.
- Location is key: You’ll want to carefully evaluate whether the property is in a location that meets your needs. If it’s too far from your primary residence, you may not be able to visit it frequently enough to make the purchase worthwhile. And if you plan to rent the property out as a vacation rental, you’ll want to choose a home in a location that’s popular enough to keep it occupied as much as you’d like.
- The ‘hidden costs’ could surprise you: From a financial perspective, buying a second home will cost you significantly more than just the monthly mortgage payment. Other expenses you should be prepared to pay include insurance premiums, maintenance costs, utility costs, taxes and furnishing costs.
- Planning ahead is important: Of course, before buying a second home, you’ll need to make some careful considerations to determine whether or not you can comfortably afford the property and all associated expenses — in addition to any other financial obligations you may have such as your first mortgage, college tuition costs, car payments, etc. Further, you’ll need to decide how you’ll finance the purchase, with the options mentioned above being among the possibilities. In addition, it’s important to determine in advance who will maintain the property so that your investment is protected. If the property is near your primary residence and you’re comfortable doing so, you may be able to perform most of the upkeep and repairs yourself. But if not, you’ll want to find a trustworthy caretaker who can reach the property quickly when needed.
When you’re ready to apply for a mortgage to cover that second home or vacation home, Arthur State Bank is here to help. And to make the process as easy as possible, we now offer online mortgage applications.
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