With more and more house hunters seeking primary residences just in the last year, many are also expected to purchase secondary or vacation properties as a home away from home.
The National Association of Realtors (NAR) reported vacation home sales increased 16.4 percent in 2020, outpacing the year-over-year primary residence market growth of 5.6 percent.
NAR Chief Economist Lawrence Yun says this trend is set to continue in the near future.
“With many businesses and employers still extending an option to work remotely to workers, vacation housing and second homes will remain a popular choice among buyers,” he tells mortgage banking news site MReport.
Yun’s predictions have been on point thus far: The NAR reported total vacation home sales increasing 57.2 percent from January to April 2021, compared with 20 percent growth the same time last year.
Considering these statistics and trends, and the freedom for a spur-of-the-moment getaway, vacation homes have become an attractive investment. Note there are several items to consider before scouting locations and listings, such as qualifications, requirements, tax implications, credit ratings, debt-to-income (DTI) ratios, and other financials. To help navigate this process, it’s best to work with a reputable lender specializing in secondary mortgages.
Learn more about the specifics of vacation home financing, such as requirements, down payments, benefits, tax implications, pros and cons, and more.
Secondary Mortgage Requirements
Prior to researching vacation home destinations and listings, it’s best to decide how much you can afford, what you can put down, and financing options. Similar to a primary mortgage, borrowers must meet certain stipulations, requirements, and qualifications.
You also must obtain necessary financial documents before meeting with your lender. Check out our recent blog: “How to Finance A Home” for more information.
Be mindful of the following requirements:
- Down Payments: Unlike a primary residence, vacation homes require a higher down payment. Plan to put down at least 10 to 30 percent of the purchase price at closing.
- DTI Ratios: It’s important to examine both front- and back-end debt-to-income ratios (DTIs) for secondary mortgages. The former states how much pre-tax income would be used for monthly mortgage payments, taxes, insurance, and utilities. The latter equals gross income for other expenses, such as credit card debt and car loans. If your DTI is drastically uneven, it’s probably best to reconsider a vacation home.
- Credit Scores: Unlike government-backed loans offered through agencies such as the Federal Housing Administration (FHA), and Veterans Affairs (VA) for active and retired military personnel, credit scores can be more forgiving. Check with your lender to ensure your credit meets your vacation home loan criteria.
- Cash Reserves: Because secondary homes carry a higher risk and can be more costly, it’s recommended to have at least six months of mortgage payments saved, for good measure.
How to Finance Your Vacation Home
With requirements and documents in order, the next step is seeking the help of a mortgage lender. As aforementioned, government-backed entities such as the FHA and VA don’t support secondary home loans. There are, however, many conventional options offered through entities such as the Federal National Mortgage Association, also known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, aka Freddie Mac. Both groups work by purchasing loans through lenders such as Contour Mortgage to navigate the secondary housing market.
Consider a few other pertinent questions before diving into to your finances:
- How Much Can I Afford? If you are barely making ends meet to pay your primary mortgage and expenses, then purchasing a vacation home might not be the best decision. Conversely, if you have a fair amount of your home’s mortgage paid off, you can use its equity for secondary financing.
- Am I Saving Enough for Retirement? Whether you are 10 or 20 years away from retirement, you’d be ill advised to drain your 401k or IRA to finance a vacation home. This increases the likelihood of a so-called house poor situation, with lapsed mortgage payments, or even foreclosure.
- Will I Need to Fund Higher Education Expenses? If you have a child or children planning to attend college, make sure you also have enough to fund a secondary home.
- Do I Have an Emergency Fund? As aforementioned, it’s advisable to have at least six months of mortgage payments and expenses in reserves. With two properties to finance and maintain, you might need to tap into this cash at some point. It’s better to be safe than sorry.
Tax Implications of Owning a Vacation Home
When filing annual personal income tax returns, primary homeowners can claim deductions earned through mortgage interest and property taxes. While this is also applicable to secondary home ownership, borrowers must consider contrasting implications, such as how often the home is utilized by the owner, versus renting it to other parties.
Per the Internal Revenue Service (IRS), if the residence is being used as a rental property for more than two weeks per year, the homeowner must report any income received as a result. Keep in mind that while you might be renting the home to others to offset expenses, such as mortgage payments, taxes, and maintenance and utilities, some of these items can be itemized as deductible expenses on your yearly income tax return.
Vacation Home Pros & Cons
When researching areas of interest, budget, and listings, consider the following important questions, and pros and cons:
- How far is the vacation home from my primary residence?
- What is the condition of the home?
- How often will I be able to use the property?
- Will I incur many extra expenses, such as flood insurance and home security devices, Homeowners Association (HOA) dues, or other fees?
- Does the investment make sense?
- Will it appreciate in value over time?
Prior to researching vacation home destinations and listings, it’s best to decide how much you can afford, what you can put down, and financing options.
Pros
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- You can renovate, personalize, and decorate the home as you wish.
- Opportunity For Additional Equity & Investments
- You’ll never experience issues with hotel bookings, cancellations, or vacancies.
- Provides a Sense of Stability & “Home Away From Home”
Cons
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- Additional Mortgage Payments, Taxes, Maintenance, Insurance & Other Fees
- Up-Front Costs Adding to Overall Expenses
- You can’t change your vacation destination each year.
- Low return on investment if you don’t use the home that often.
The Takeaway
Purchasing a second home or investment property can provide myriad benefits, such as the financial freedom to pursue other interests. While the terms and requirements are different, you can still acquire a competitive secondary mortgage by working with the right lender, such as Contour Mortgage.
Contour Mortgage can assist with financing a cabin, lake house, or second home for weekend getaways or family vacations. Contact us for a free consultation and quote.
