For various reasons, many homeowners give thought to buying a second home as a vacation escape, some rental property, or even as a long-term investment. But one of the most pressing questions to answer before making that decision, is it cheaper to purchase a vacation home? How can that be the answer when there are so many financial variables involved different types of mortgages, interest rates, loan requirements, ways to finance, and so on?
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Purchasing a secondary home is different from buying a primary residence. Second-home mortgages tend to come with more stringent requirements, higher interest rates and extra costs, especially if you’re not using a lender. Such financing for second homes is the focus of this article, which will explain how buyers can find the best financial deal on that second home.
Second Home Mortgage Options
Conventional Loans
A conventional loan is the most common second-home financing option. Those loans are not government-backed, and lenders use their own qualifications.
Main characteristics of traditional loans for second homes:
You should expect to put more down (typically 20-25%) than on primary home mortgages.
The interest rates can be fixed or adjustable, but they are usually higher than the rates for a first home.
The deal with a high credit score (generally 680 or better) and a low debt-to-income ratio.
Conventional loans work well for buyers with solid finances who can cover the up-front costs.
Jumbo Loans
If the second home is in a high-cost area and the price exceeds the conventional loan limit (which varies by location), buyers may require a jumbo loan.
Features of jumbo loans:
Higher loan limits, so they can be used for expensive properties.
Larger down payments (generally 25-30%) are required.
Tighter credit requirements, typically requiring a score of 700+
Higher interest rates since lenders assume more risk
For buyers who want to buy luxury properties, or homes in expensive markets, jumbo loans are the way to go.
Home Equity Loan or HELOC
Home equity loans or home equity lines of credit (HELOCs) can be used to pay for a second home for homeowners who have already built up a good deal of equity in the primary residence.
Home Equity Loan: A one-time loan secured by your primary home’s equity. With fixed interest rates and predictable monthly payments.
HELOC: A line of credit, like a credit card, allowing borrowers to withdraw funds at any time. Its interest rates tend to be variable.
These options may be appealing because they frequently carry interest rates lower than standard second-home mortgages. But they put your primary home in jeopardy if you can’t make payments.
Cash-Out Refinance
For example, a cash-out refinance allows homeowners to refinance their primary residence for more than they owe on the home and use the extra cash to purchase a second home.
Pros of cash-out refinancing:
Interest rates are lower than second-home mortgages.
Able to pay a big down payment or purchase it in full.
Fewer mortgages to have to handle, instead of two.
Refinancing does increase the amount you owe on your primary home, though, which often leads to a longer loan term and higher monthly payments.
The Basics of Second-Home Loans That Impact Prices
Higher Interest Rates
Second homes are also considered higher risk by lenders than primary properties. As a result:
Interest rates on second-home mortgages tend to be 0.5% to 1% higher than on first-home mortgages.
People with great credit scores (740 or above) will receive the best rates.
The initial rate on adjustable-rate mortgages (ARMs) may be lower, but they can rise over the subsequent years.
Shopping around for different lenders and negotiating for lower rates can save buyers thousands of dollars over the life of the loan.
Larger Down Payments
Most lenders do require a minimum 20-25% down payment for second homes. That’s more than the 3-5% typically needed for a primary home.
A bigger down payment shrinks the loan and results in lower monthly payments.
Buyers who can put down 30% or more may be eligible for more competitive interest rates.
A hefty down is enough to avoid private mortgage insurance (PMI), which applies to loans with less than 20% down.
For buyers who find saving for a large down payment challenging, they might lean toward alternative financing options such as home equity loans or cash-out refinancing.
Debt-To-Income Ratio (DTI) Needs
Lenders look carefully at a buyer’s debt-to-income ratio (DTI) to ensure that the buyer can afford a second mortgage.
The industry standard: a DTI of less than 43%, which means that monthly debts (including the new mortgage) shouldn’t total more than 43% of monthly gross income.
A lower DTI improves the chances of being approved for a loan and qualified buyers for better interest rates.
If a buyer has high existing debts, they may need to pay down credit cards or loans before applying.
A good DTI ratio shows lenders you’re financially capable of taking out a mortgage, boosting your chances of approval.
Ways to Reduce Second-Home Financing Costs
– Increase Your Credit Score: With a 740+ credit score, you should be privy to the best rates in the mortgage market. Pay down existing debt and keep credit utilization low.
– Save For A Bigger Down Payment: A bigger down payment lowers the cost of interest and removes PMI from the down payment equation.
– Shop Around: Banks and lenders offer different rates and terms. Bargaining around guarantees you have the perfect deal.
– Explore Other Financing Options: Home equity, a second-mortgage or HELOC might give you lower rates than a second-home mortgage.
– Buy in a More Affordable Market: Selecting a second home in a less expensive market can help lower your mortgage and insurance bills and property taxes.
Is Buying a Second Home Less Expensive?
Final Thoughts
So is a second home cheaper to buy? The answer is contingent on what financing strategy is utilized and the buyer’s financial situation. Although mortgage rates and minimum down payment requirements are usually higher on second homes, smart preparation like accessing home equity or refinancing can lead to a more affordable purchase.
When purchasing a second home, make sure to analyze mortgage options, interest rates, and the long-term cost, to guarantee financial security. Buyers can use this information to obtain the most competitive loan terms and get the best deal possible on their investment.
Home Buyers & Investors: Visit Grit Build foring expert advice on home construction, property investment, and effective financing solutions tailored to your needs.
