If you’re a family that goes on multiple vacations every year, then buying a second home is a must. Financing your second home or vacation home using a mortgage is a good idea instead of paying in cash. Generally, individuals use a home loan as a financing option to invest in a second home. If you are tired of living in hotels and resorts during holidays, you can plan to buy a vacation home using a mortgage and also build equity at the same time. You must know that your second home is not your primary residence. Hence, the rules and eligibilities for a second mortgage are a little different.
Before applying for a second mortgage*, a borrower must be aware of the eligibility criteria. The credit score requirement for a second housing loan is higher than the first home. The interest rates for a second home mortgage are lower than rental or investment property loans; however, the home loan interest rates are higher than the first home mortgage.
A benefit of having a second mortgage is that the borrower may cover his monthly mortgage payments by renting out their second/vacation home. Even if it is rented, it would be still be considered a vacation residence.
Requirements to Apply for Second Home Mortgage
The requirements for a second home mortgage are more stringent than a first home. As per the two government agencies that fix the loan conforming guidelines – Fannie Mae and Freddie Mac**, the requirements include negotiable and non-negotiable terms.
- The non-negotiable requirement is that you need to at least pay a 10% down payment.
- A borrower with a credit score of 680 or more can get approval for a second home loan.
- If you have a credit score of 640-679, then you can get approval for a mortgage with a down payment of 25% or more.
- The acceptable range for debt to income ratio is up to 45%.
An ideal borrower meets all the above-given conditions. But if in one of the requirements, your chances are low. You can cover it up with other more vital points. For example, if you have a lower credit score of 640, you can still get a mortgage with a higher down payment equal to or more than 25%.
Second Property Requirements
Apart from the above individual requirements, the property itself has to meet specific guidelines set by the agencies –
- The owner should occupy the second home during the year for a reasonable time.
- It should be a one-unit home. It should not be a duplex or triplex.
- It should belong solely to the buyer.
- It should not be managed by an operating company in terms of occupancy.
- The property should be suitable for use around the year.
The first rule is very significant. It explains that you cannot finance a second home mortgage if the property is rented out full-time. To be eligible for a mortgage, the owner must reside in the second home for some time during the year. This suggests that your second home must be treated as a recreational residence.
What are the best ways to Finance a Second Home Mortgage?
To buy a second home, the best way is to finance your new property through the use of home equity. Most families have the largest available asset as home equity. As borrowers offer high-quality collateral to lenders, they get access to lower interest rates with home equity loans, reverse mortgages, cash-out refinancing, etc.
Home Equity Financing
It is a standard mortgage loan that allows borrowers to access a large amount of cash for a home purchase at a lower rate of interest. This form of home equity financing is one of the most popular and easiest ways to finance your second home. Being a secured form of financing, lenders do not interfere with how cash proceeds are used after disbursement.
Types of home equity financing
Home equity loans– A borrower can get money against the equity created with your home. The repayments are made in equal monthly installments over time, similar to a standard mortgage loan for a first home. The borrower gets a lump-sum payout at a fixed rate of interest for the housing loan duration. As the rate of interest is fixed, the borrower can plan to repay with discipline. With home equity loans, borrowers can get a large amount of cash to buy a second home at lower interest rates. A borrower must ensure to avoid any default in payments that would adversely impact their credit score.Home Equity Line of Credit- (HELOC)- A HELOC sounds similar to home equity loans. A HELOC works like a credit card. The borrower can withdraw funds whenever needed. The benefit of a HELOC is that you are bound to pay interest only when you withdraw funds..
The two important terms for a HELOC is draw and repayment period. The credit limit set by the lender is based on your credibility. You can withdraw funds as much you can within the limit. During the repayment period, you have to pay the interest charges for the funds utilized. The benefit is that the borrower has to pay only the interest charges and not the principal. Other benefits of HELOC are flexibility in use, quick source of funding, tax concessions, etc.
Another option to finance a second home is through a reverse mortgage. A reverse mortgage is available when you are 62 years old or more. Such loans are government-sponsored loans allowing borrowers to avail funds without requiring repayment until you leave or sell your home. A reverse mortgage is an attractive loan option for senior citizens wanting to buy a second home without giving away their savings.
Under this loan option, the interest accrues until it remains outstanding. The balance of payments keeps on increasing if the prices are not made. After the borrower’s death, the legal heirs are responsible for the exceptional loan if they wish to possess the asset. If the balance outstanding is high, lenders may force the legal heirs to sell the property.
Another way of arranging funds is cash-out refinance. Under this, you refinance your mortgage available at lower rates of interest than your current interest rate. The loan is against the difference between the equity and outstanding loan of your home. It increases your monthly payments as a larger amount is now exceptional.
Another exciting way to finance your second home is to find out a seller that already holds an FHA/VA loan. This means that you can take over the mortgage payments from the seller of the property. It is only possible when the seller has an outstanding FHA or VA loan at a lower rate of interest. If you are lucky, you can identify a seller wishing to sell his/her vacation home with an outstanding government-backed mortgage.
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