When comparing mortgage quotes from competing lenders, let lenders know if the property will be your primary residence, a vacation home or an investment. Because the way that you plan to use the property affects your mortgage rate, you must provide this information to get accurate quotes.
How your property’s use affects your mortgage rate
The cheapest financing is reserved for primary residences – the home in which you live, or plan to live. Some lenders charge more to lend on vacation property, and most impose much stricter underwriting guidelines. Investment property means a home that you rent out or plan to resell quickly at a profit. These are considered the riskiest loans for mortgage lenders, so plan to pay higher fees and / or make a much larger down payment.
How much more does it cost to finance a rental? A borrower with a 680 FICO score pays an extra three points in fees to finance an investment property with a Fannie Mae or Freddie Mac loan – that means you pay an extra three percent in closing costs or accept a mortgage rate that’s .375% - .5% higher! Why so much? Because if an investment property becomes a bad investment – the rental income is less than you expected, or the home’s value drops – there is little incentive to keep making your payments. Even the Mortgage Bankers Association defaulted on its $75 million loans for its Washington DC office building, eventually short-selling it for $41.3 million, because it had difficulty finding tenants and decided that continuing to own the building was “economically imprudent.”
OK, so what if you don’t need the rental income to qualify for a mortgage? Can you just call your rental a second home and get a better deal on your mortgage? It’s unlikely. Fannie Mae lists these requirements that must be met in order to finance property as a second home:
- The property must be reasonably far away from your primary residence, because no one vacations in their own town.
- You have to occupy it for some part of each year.
- It must be a 1-unit place, because multiunit homes are generally rented out.
- It must be suitable for year-round occupancy.
- You must have exclusive control over the property -- no management companies and no time-share arrangements.
What about a VA mortgage or FHA mortgage? Sorry; these loans are not available for the purchase of rental property. However, you can assume an FHA mortgage to buy an investment property as long as the loan-to-value ratio is 75 percent or lower. If you purchase a home for $100,000, the loan to be assumed can’t exceed $75,000 – if it does, you’ll have to pay it down to $75,000 or less.
As long as your mortgage amount falls within limits set by Fannie Mae and Freddie Mac, there are no additional fees for buying or refinancing a second home. If your vacation home is more expensive, however, you’re looking at jumbo or non-conforming financing. Jumbo mortgage lenders typically add about .5 percent to your fees or .125 percent to your rate to finance vacation property.
What about government mortgages? Sorry; government home loans are for people buying their primary residences only. However, you are allowed to assume a seller’s FHA loan when you buy your second home, as long as the loan-to-value ratio is 85 percent or lower. If you buy a vacation place for $100,000, for example, the loan that you assume cannot exceed $85,000 – if it does, you’ll have to pay it down to $85,000 or less.