Mortgage Options for Vacation Homes

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Buying a vacation home can be part of a long-standing dream for many people. While this is a major purchase with similarities to buying a primary residence, there are some notable differences.

Vacation Home vs. an Investment Home

How you characterize purchasing another home will determine how it can be financed. Some people buy it strictly as a vacation home, while others buy it as an investment home with an eye toward offsetting costs through rentals.

If you don’t currently own a home, a vacation home can be your primary residence. You can qualify for a home loan with just 3% down on a conforming loan and take advantage of homeowner tax benefits.

If the property is a second home, plan on putting 10-20% down. From there, you must decide if it is used strictly as a personal vacation home or if you will use it as an investment property and rent it out when you’re not occupying it. 

A good test for this is that if you live there less than 14 days annually, it’s considered an investment property, which will change the terms of the loan you seek.

According to industry experts, if you don’t need rental income to afford the second home, you’re better off buying it as a vacation home and should get a slightly lower mortgage rate than an investment property. A vacation home is treated as a second home, and lenders generally have the same requirements as a primary home. 

If rental income is part of the plan when purchasing a second home, qualifying for a loan will require more work. In some cases, your lender will want to see an appraisal with a rental schedule that details the property’s potential income.

Lenders will count 75% of the anticipated rental proceeds as income to you. This allows for chunks of time when tenants don’t pay, or the property sits empty between rentals.

A vacation home does not have rental income to offset the mortgage payment, and you’ll need to find other sources of income from your available assets to meet financial loan requirements.

Down payment amounts differ as well. You can finance a primary home for as little as 3% down. But lenders usually require at least 10% down for a vacation home and 20% or more for an investment property.

Options to Finance a Vacation Home

There are several financing options for a vacation home purchase.

Conventional Mortgage

A conventional mortgage is a loan from a private lender such as a bank that’s not backed by a government agency such as the FHA, VA, or USDA. Government-backed mortgages aren’t available for the purchase of a vacation home.

The government only finances loans for primary residences or first-time homebuyers.

Lenders typically finance a fixed-rate mortgage on vacation homes, which locks in a certain mortgage rate for a specific term of up to 30 years. Adjustable-rate mortgages (ARM) on vacation homes lock in your interest rate for a set initial period, usually between 5-10 years, before the interest rate is adjusted to current market conditions.

Home Equity Loan or HELOC

A homeowner may be able to leverage the equity in the primary residence to come up with funds to buy a vacation home. Home equity is the difference between what a home is worth and how much of the mortgage remains unpaid.

Your homeownership stake becomes the collateral for your loan or HELOC.

Cash-out Refinancing

You can obtain a bigger mortgage through a cash-out refinancing to replace your current, smaller mortgage. The overage can be converted to cash then used to finance a vacation home purchase.

Key Documents You’ll Need

To buy a vacation home, you’ll need to submit key documents, including the following:

Proof of Income and Employment 

For a borrower with a traditional job, a lender usually requires recent pay stubs and two years’ worth of W-2 forms as proof of income and employment. For a self-employed borrower, a lender will want to see two years of personal and business tax returns, a year-to-date profit-and-loss statement, and a business balance sheet. 

Financial Statements

Lenders will also want to see bank and investment account statements, as well as recent mortgage statements for your primary residence.

Monthly Debts 

To ensure you can handle the added monthly obligation, lenders will also want to see recent credit card bills, home insurance premiums, personal loan payments for cars, student debt and other personal encumbrances.

Financial Requirements

  • Financial requirements may vary slightly from lender to lender, but in general, here’s what it will take to qualify for a loan.
  • FICO score of at least 620 and possibly 660.
  • Debt-to-Income ratio of 45% or below which may vary slightly in some cases.
  • At least a 10% down payment, which differs from primary residences that may only require a 3% down payment.
  • Adequate assets in savings, checking, and investment accounts to counter risks if the borrower runs into financial issues. You’ll likely need 2-6 months of mortgage payments in reserve for a vacation home purchase.

Choosing a Lender

You should shop for a lender that best meets your needs for a vacation home mortgage. Decide if you’re comfortable with a large bank, regional institution, credit union, or an online-only lender.

Read reviews and pay close attention to any red flags. Also, check how much experience a lender has with second homes so they can guide you with their existing knowledge.

From there, ascertain the lender’s requirements, including a minimum FICO score, down payment amounts, debt-to-income ratios, and other important factors. Part of this includes application, origination, servicing, and other fees that add to the cost of your purchase.

Ask what the overall APR is, which comprises the base interest rate and fees into a single fee that makes it easier to compare between lenders. 

Aaron Crowe

Aaron Crowe is a seasoned personal finance and real estate journalist. Aaron writes on real estate as it relates to mortgages, refinancing loans and lending for Refi.com.

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