A guide to buying a second home

Buying a second home is a big commitment. It may be your first experience with real estate investments, or it could serve as your vacation home for part of the year.

However, there are considerable costs involved, and your mortgage options may vary depending on what you intend to do with the property. In this article, we’ll go over the steps to buying a second home and financing options.

Reasons to buy a second home

There are several types of properties and a number of reasons why people might want to buy a second home. Below are the most common reasons.

Investment property

An investment property is real estate purchased with the intention of making a profit, either through rental income or appreciation. One option is to buy a home, fix it up and then flip it for a profit. Another is to purchase the property and either turn it into a short-term rental, like an Airbnb, or a long-term rental property and collect rental income.

Vacation home

A vacation home is a secondary property mainly used for recreation or vacationing. When not being used by the property owner, vacation homes may also be rented out to generate passive income. Some lenders require that you spend a certain number of days at your vacation home. Others may also require the property to be a minimum distance from your primary residence.

Second home

A secondary residence is a home you live in for part of the year in addition to your primary residence. According to the IRS, a second home is one that you live in for at least 14 days during the tax year.

You can also generate income from a second home. Your property may still be classified as a secondary residence rather than an investment property as long as you live there for a number of days equal to at least 10% of the days the home is rented, or 15 days per year. Guidelines for tax purposes are very specific, so be sure to do your research.

Rental property

Buying a rental property is similar to purchasing an investment property. A rental property is a type of real estate investment, but the sole purpose of the property is to rent to short- or long-term tenants and generate passive income. A residential rental property can be a single-family home, condo, apartment, townhouse or a duplex.

Can you afford to buy a second home?

Buying a home, whether it’s your primary residence or a second home, is a big financial investment. However, the process of buying a second home will look a little different.

Similar to buying a primary residence, mortgage lenders will look at your income, assets and credit history to determine whether you’re financially prepared to make the commitment. But be prepared to make at least a 10% down payment on a conventional loan, and 20% or more on a jumbo loan. You’ll also need to meet the lender's income, credit score and debt-to-income requirements, which vary by lender and loan type. These requirements tend to be stricter than for a primary residence.

Qualifications for buying a second home

Below are key factors a lender will consider before approving financing for a second home.

• Credit score: Lenders will view your credit score differently for a second home and typically require a higher credit score than they would for a primary residence. Requirements vary by lender, but a credit score of 700 or above should help you qualify for a loan on a second home.
• Debt-to-income ratio (DTI): Lenders will require a lower DTI when taking out a mortgage for a second home. In most cases, experts recommend a DTI of 43% or less to qualify for a loan.
• Income: If you have a mortgage on your primary home, then lenders will need to see that you have a high enough income to make payments on an additional mortgage. Income requirements vary by lender and the size of the loan.
• Cash reserves: When buying a second home, a lender will want to see that you have enough cash reserves to cover your mortgage payments in case there’s a temporary loss of income. Highly qualified borrowers will likely need at least 2 months of reserves, while less qualified borrowers may need at least 6 months of cash reserves. One month of reserves should be enough to cover the monthly mortgage payment for both properties.

Qualifying for a loan on a second home is often more difficult than it is for a primary home. Lenders are more careful about approving financing on second homes because there’s a higher risk of default on the mortgage. If a borrower already has a primary mortgage, it may be more difficult to manage payments on a second property. Additionally, most borrowers prioritize payments on their primary residence over a second home during times of financial hardship. This increases risk for lenders, and they may not be able to recoup their investment in the event of default on the loan.

The costs of buying a second home

The costs of buying a home are a bit different for second homes as you’ll have expenses to consider beyond closing costs and monthly payments. Here are costs that home buyers will need to consider and how they might be different for a second home.

• Homeowners insurance: Homeowners insurance on a second home may cost more than on a primary residence. You may also need a different type of insurance depending on whether the second home is occupied and if you’re renting out the property.
• Down payment: Lenders may require a larger down payment, generally between 10% for a conventional loan and 20% or more for a jumbo.
• Property taxes: In addition to your primary residence, you’ll also need to pay property taxes on your second home, depending on the taxable value of the property.
• Maintenance: Similar to your primary residence, you’ll need to maintain your property even if nobody is living there full-time. Hiring a property manager may help you stay on top of maintenance and upkeep, but it will cost more.
• Utilities: You’ll need to factor in the cost of utilities, such as electricity and water. These costs may be lower for a vacation home compared to an investment property that you rent out for the majority of the year.
• Travel: Traveling back and forth between your homes costs time and money. Travel expenses can add up substantially over time.
• HOA fees: If your second home is located within a community with a homeowners association (HOA), you’ll need to factor those fees into your budget.

The tax effects of buying a second home can also be different depending on the property type. For example, if you rent out your home for more than 14 days and earn rental income, you must report the revenue on your tax return, and the net income is taxed as ordinary income. Consider consulting a tax professional about the full tax implications.

How to buy a second home

As a homeowner, you may be familiar with the home buying process. However, the process of buying a second home is a little different. Here are the steps.

1. Decide what type of second property you want

The first step when buying a second home is to determine the type of property you want to purchase. Consider the reason why you want to purchase the property. Do you want a home where you can vacation or live part-time, or do you want a property that will earn you passive income? How you plan to use the property will help you decide whether the home will fit into your budget and whether it matches your needs.

2. Get preapproved

Getting preapproved for a mortgage is an important step in the home buying process. This will better help you understand the type of property you can afford. Plus, most sellers won’t accept an offer from buyers without a verified approval. This is a preapproval letter that includes verification of the borrower’s income, assets and credit score.

3. Find the right real estate agent

It’s a good idea to work with a real estate agent who is familiar with the local market to buy a second home. A knowledgeable real estate agent will know what’s required in your local market, give you expanded search power and can help you negotiate a fair price with the seller. Find an agent with experience buying homes that are similar to the one’s you’re interested in.

4. Make an offer

Once you find a property that you’re interested in, your real estate agent can help you put together a competitive offer. Your agent can also negotiate the price with the seller on your behalf. Once your offer is accepted, you’ll get the home inspected and appraised before beginning the closing process.

5. Close on your second home

Before you receive the keys, you’ll go through the closing process on your second home. You’ll make the necessary down payment, buy homeowners insurance and title insurance and then sign all closing paperwork.

Financing a second home

Here are some options when it comes to financing your second home:

• Conventional loan: A conventional loan is a loan that isn’t backed by a government agency. Conventional loans are the most common financing option that borrowers use. Most conventional loans for a second home require a down payment of at least 10%.
• Jumbo Loan: You can use jumbo loan to finance part of your second property if it exceeds the maximum amount for a conforming loan. Your lender may require a down payment of at least 10%, and often 20% or more.
• Home equity loan: A home equity loan lets you tap the built-up equity in your primary home to use as a down payment on your secondary residence.
• Cash-out refinance: If you have enough equity in your primary residence, you may be able to do a cash-out refinance. This option will replace your current mortgage and borrow against the equity in your home to use as a down payment. Keep in mind that you’ll need to pay closing costs twice.

The bottom line

Buying a second home opens up the door to potential income or a place to use as your personal escape. Before you jump in, make sure you’re financially prepared to keep up with costs and take the time to find the right type of property that matches your budget and needs.

Ready to get started? Connect with a real estate professional today to begin the home buying process.