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4 Steps to Buying a Vacation Home

Buying a vacation home is a luxury, but it doesn’t require you to have limitless cash on hand.

In fact, you can finance a vacation home by tapping into the home equity you already have to cover your down payment. Or you could bring in a co-borrower to split the upfront and ongoing costs.

4 steps to buying a vacation home

1. Determine whether you can afford a vacation property

The first question to ask yourself is: Can I afford a second home? After all, that’s another mortgage to juggle if you still owe money on your first home and aren’t paying for the vacation property outright. Use LendingTree’s home loan calculator to estimate what your monthly mortgage payments on a second home would look like.

Besides principal and interest payments, there are homeowners insurance premiums and annual property taxes to consider, along with other ongoing expenses such as maintenance and utilities. If you don’t have a plan or the cash flow to manage all of these costs without overextending yourself, you may not be ready for a vacation home investment.

2. Be sure you qualify to finance a vacation home

Mortgage lending requirements are stricter when buying a vacation home compared to a primary home. This could be because homeowners who run into financial trouble are more likely to pay the mortgage on their main home than on a vacation home they visit only occasionally.

You could qualify for a conventional loan on a primary residence with as little as 3% down, but you’ll need a minimum 10% down payment for a second home. A large down payment could also help you get a better mortgage rate and lower monthly payments.

To qualify for a conventional loan, your second home must:

  • Be a one-unit property that’s available and suitable for year-round use.
  • Be occupied by you, as the borrower, for some portion of the year.
  • Be controlled exclusively by you and not a property management company.
  • Not be a rental property or timeshare arrangement.

3. Gather quotes from multiple local lenders

You might find more affordable loan terms by working with a mortgage lender that’s local to the area in which you’re buying a vacation home. Get home loan quotes from three to five lenders and compare interest rates and loan terms.

Ask each lender for a worksheet of cost estimates. Pay attention to the estimated mortgage rate, lender fees and other closing costs. Follow up on any line items you don’t understand and try to negotiate lower fees where you can.

4. Find a local real estate agent

Take some time to research real estate agents who are local housing market experts where you’re buying your second home. You can find nearby agents through an online search or by asking for recommendations from friends and relatives.

You should interview each agent to get a feel for their expertise. Ask questions and share your vacation home goals. Don’t forget to negotiate upfront on agent commission fees.

How to cover your vacation property down payment

You’ll need some skin in the game to get a mortgage for a vacation property. Here are a few creative ways to finance a second home down payment:

Get a cash-out refinance on your primary residence

A cash-out refinance allows you to take out a new mortgage for more than you currently owe. The new mortgage pays off your existing loan and you receive the difference between the old and new loan in cash. You can use the money as a down payment on your second home.

This type of refinance could be an especially good option if you can qualify for a lower interest rate than what you’re already paying. The lower your rate, the lower your total interest expense over the life of the loan.

Keep in mind you can’t deduct mortgage interest on the cashed-out portion of your refinanced loan if you use the money for any purpose other than improving your primary home.

Take out a home equity loan or HELOC on your primary residence

Another option is to tap the equity in your primary home through a home equity loan or home equity line of credit (HELOC) to cover your vacation property down payment.

You receive a lump sum when taking out a home equity loan. The interest rate is typically fixed and the payments are made in equal installments, which could make it easier to plan your finances.

With a HELOC, you borrow against the credit line as you need the money during your draw period, then make principal and interest payments when that period ends. Similar to credit cards, HELOCs have variable interest rates and you pay interest only on what you owe. This can be a viable option if you’re working with a lender who doesn’t offer home equity loans or if the vacation property needs repairs or upgrades over time.

Like a cash-out refinance loan, you cannot deduct the mortgage interest paid on a home equity loan or HELOC unless the money is being used to “buy, build or substantially improve” the home that’s securing the loan.

Partner with a co-borrower

For some, splitting the cost with a friend or relative might be the only way to make a second home affordable. You’ll be splitting the down payment and sharing in the ongoing maintenance, repair, utility and tax expenses.

When you apply for a mortgage with a co-borrower, the lender considers each applicant’s credit profile. A credit report and score will be pulled from each of the three major credit bureaus (Equifax, Experian and TransUnion). The lender takes the second-highest (middle) credit score from each applicant and uses the lowest middle score among the applicants as the qualifying score.

Hiring a real estate attorney to put the details of your joint purchase in writing could be a worthwhile investment. Questions to answer in that document include:

  • What’s the best ownership structure?
  • Who gets to use the home during which days and months?
  • What’s the recurring cleaning schedule?
  • What happens when one borrower wants to remodel?
  • What happens if one or all borrowers are ready to sell the home?
  • What happens if one borrower can’t afford their portion of the mortgage payment or a repair?

Financing a vacation home vs. an investment property

When you’re buying a vacation home, how often you actually use the property matters, especially during the mortgage approval process.

If you plan to use it primarily as an investment rather than a vacation property, your mortgage lender will likely classify it as an investment property and not a second home. This affects your eligibility requirements, such as your minimum down payment and cash reserves amount, or the number of monthly mortgage payments you should have set aside in a savings account.

Getting a conventional mortgage on a vacation vs. investment property
Vacation property Investment property
Minimum down payment 10% 15%
Credit score needed for
minimum down payment
720 700
Maximum LTV ratio 90% 85%
Maximum DTI ratio 45% 45%
Minimum cash reserves 2 months 6 months

 

While second or vacation homes require a 10% minimum down payment, you must put down at least 15% when buying an investment property. In some instances, the down payment requirement can increase for both property types if your credit score is lower or debt-to-income (DTI) ratio is higher.

Interest rates are usually higher on mortgages for investment properties — your mortgage rate can range from 0.50 to 0.875 percentage points higher than mortgage rates for an owner-occupied home.

An upside to financing an investment property is that mortgage lenders often use 75% of the projected rental income as part of the process to determine whether you qualify for the loan.

Buying a vacation home as an investment

You may still be able to use your vacation home as an investment property and reap some tax benefits, if you follow IRS rules. You must live in your second home for more than 14 days or 10% of the time that it’s available for rent — whichever period is longer.

There are tax implications if you rent out your second home, depending on how often it’s rented.

  • If you rent out the home for up to 14 days each year, the income may be tax-free.
  • If you rent it for 15 days or more, you’ll have to report the rental income when you file your annual tax return.

You can also deduct rental expenses, such as mortgage interest and maintenance, when you rent your second home for at least 15 days. A portion of your property taxes, utility bills and depreciation may also be deductible. Consult your tax professional to better understand what’s at stake; they can provide more details and help you strategize your best approach.

Remember to factor in the expenses you’ll likely incur to maintain your vacation property while renting it out. For example, a professional cleaning service could cost between $50 and $90 an hour — an expense you’ll need to budget for when setting rental rates.

 

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