Financing Options for Vacation Homes

Have you been dreaming for years of buying a vacation home at your favorite getaway spot? Whether it’s on the beach, on a golf course, or overlooking a ski resort, it’s likely you can bring your dream to reality. Don’t believe me? Take a look at the recent spike in the purchases of vacation homes. In 2014, the National Association of Realtors® (NAR) reported that around 1.13 million units changed ownership. Not only was this figure up by a staggering 57% over the previous year, but it was the highest level recorded since the NAR surveys began in 2003.

How are so many people affording their dream homes?

In 2015, the NAR reported that 62% of buyers turned to financing while 38% paid in cash. With financing being the most popular path, let’s take a look at your options.

Vacation home buyers prefer financing. (Source)

Financing Options for Vacation Homes

The two main routes you can take are going to be turning to a traditional source like a bank for a conventional second mortgage loan, and taking out a home equity loan or HELOC on an existing property. Here is what each of these options entails.

Conventional Loans

Conventional loans are offered through banks and credit unions across the country and are similar to the loan you get for a primary residence. You will be asked to put down an initial amount and then will be set up on a payment plan over a set amount of years (typically 15-30) with either a fixed or adjustable interest rate.

If you’d like to calculate how much a specific loan is likely to cost you, head over to this second home mortgage calculator.

The difference between a conventional loan for a second home versus for your primary home is that a larger down payment is required. Typically, you will be expected to put down at least 10% and may be asked for up to 30%, depending on the lender.

It can also be harder to get approved for this kind of loan compared to a primary mortgage. You will need a high credit score and sufficient income and asset documentation to show a strong debt-to-income ratio. Why? Lenders want to make sure you are a safe investment and can afford both homes.

They will also be looking at a few factors to confirm that your home is a “vacation home.” If you are planning on renting it out, it becomes an investment property which is financed under different terms. A vacation home reaps the rewards of lower interest rates.

Let’s look at a second conventional loan offered by Quicken Loans as an example.

With Quicken, a down payment of as little as 10% is one of the primary vacation home loan requirements that needs to be met. Loans are pre-approved which also shows intent on your part to the buyer while providing you with some leverage when negotiating the final price. A vacation home mortgage calculator allows you to make accurate calculations when it comes to monthly loan repayments and overall loan values. There are two loan options available. First, a 30-year loan with fixed rates of 4.125%. Second, a 15-year loan with an interest rate of 3.25% for those who prefer to pay off their mortgage quicker.

This is just one of the many providers that you can compare and review here.

Home Equity

The second option available when looking to buy a vacation home is tapping into your existing home’s equity. Of course, this option requires that you already own property. There are two approaches you can take here.

  • The first is cash out refinancing which works great when a home’s value rises leaving you with equity.
    With this approach, you refinance your existing mortgage into a bigger loan, and then you take out the difference to use for your second home. You may be able to renegotiate a lower interest rate but will also pay closing costs on a new loan.
  • The second is a home equity line of credit (HELOC) which is the most popular option according to NAR’s vacation home buyer survey.
    Many lenders, including banks and credit unions, are offering these and some allow for you to tap into 100% of your home’s value. With this approach, you take out a line of credit backed by the equity you have in your home. This way your primary mortgage stays the same and an additional loan is added. Good to excellent credit is usually required for a HELOC, and they allow you to skip the closing costs. As for the interest rates, they are typically variable, while home equity loan interest is usually fixed.

Want an example? Let’s analyze the loans offered by Blackhawk.

They offer both a HELOC and a conventional loan. For the home equity line of credit, they offer up to 90% of the value of your home. For the second mortgage, you borrow a specific amount which is then paid back within an agreed upon period. In most cases, interest rates are first fixed for up to five years, after which they are amortized for the remaining period, usually 20 years.

This is just one of many examples of loan providers and loan options available. Click here to compare and review a range of others.

How to Buy a Second Home with No Down Payment

Many buyers want to know if it is possible to buy a second home with no money down. Currently, in the US, the government offers zero-down payment options when it comes to financing a primary residence, but unfortunately, not for a second home.

When looking at the stats, around 50% of buyers had to make a down payment of 30% and in some cases, even more.

But how can you cut that down?

First, shop smart.  Compare a wide range of lenders to find the best terms for your situation.

Next, the National Association of Realtors® confirms that around one-fifth of buyers use equity from their main residence as a way to make the downpayment on a second home. Furthermore, Glenn Carter, real estate investor and expert at Condo.Capital, offered the following advice,

Typically a requirement of 5% is needed for any owner-occupied property, including a vacation home, so no real 0% down arrangement works. But, you can leverage the equity in your primary residence to use as the 5% down. This is typically done through a home equity line of credit (HELOC), and is a low-interest rate because it’s secured against your primary residence.

So the cash out refinancing or HELOC can be used to get you the money you need for a down payment. While you’re not putting $0 down, you do avoid putting down any money out-of-pocket.

Carter further advised,

I also hear of people/families buying a property together, therefore cutting the down payment in half, a third, or even a quarter. In this case, you really have to be comfortable with who you’re buying with, but I’ve even done this for a vacation property in Florida. I split the down payment with friends of ours, and we are joint owners.

Lastly, you can also consider a Purchase Money Second Mortgage, also sometimes called a ‘piggyback’ second mortgage. As the name suggests, this is taken out at the same time as your loan.

Piggyback loans are usually split in the following loan-to-value configuration – 80/10/10 where 80% is the mortgage, 10% is the second loan, and 10% covers down payments or the ‘purchase money’ so to speak. Also, interest rates here are generally variable, so a rise in the prime lending rate will increase monthly installments. This could be a good option if you are financially stable but just don’t have the 10%-30% to put down.

Vacation Home Loan Requirements

Now that you know what financing options are available let’s take a deeper look at the requirements needed to secure a home loan for a vacation home.

Good Credit

A good credit record is essential. Your score will usually need to be around 650 or higher to qualify. Of course, the higher it is, the better the chance that the loan will be approved. A higher credit score can also help to secure better overall terms for the loan.

If you are unsure of your credit record, you can always check it before you apply. This is not only a great way to find out how good or bad it is but enables you to fix any errors that may appear.

Check your credit report and score here for free.

Higher Down Payment

Be ready to have your down payment of 10%-30% on hand or have a plan for how you can get it. The upside? If you can put down a higher amount, you can secure better interest rates. Furthermore, if you put down over 20%, you can avoid paying private mortgage insurance, or PMI, premiums. PMI is an insurance that protects the lender if you stop making payments on your loan.

Cash On Hand

Having cash on hand is critical. This is not only needed to cover the down payment and closing costs but to show lenders that you are financially stable. They may look for reserves to cover 2-6 months worth of rent on both your primary and secondary residence just in case you lose your job. This will vary depending on the lender and your profession.

Low-Income to Debt Ratio

Another area lenders will look at is your debt-to-income ratio. For most, this will need to be in the region of 43% or lower, both for your main home as well as the vacation home you intend to buy.

But what does this mean?

Simply put, the cost of your expenses (encompassing the two mortgages, taxes, car payments, and any other loans or household debt) must not exceed more than 43% of your total income. If you are close to this percentage, a higher credit score can still help secure the second loan as well as a larger down payment.

Be ready to show at least two months of bank statements, two years of tax returns, two years of w2’s, one month of pay stubs, and investment properties owned, and records for retirement accounts, social security, pension award letters, and two years of 1099s.

Proof it’s a Vacation Home

If you are buying a second home and intend to rent it out at any point, many lenders will simply not give you a vacation home loan. This is because mortgage rates for a second home vs. an investment property can differ significantly. If you plan to use the home during the summer but rent it out at other times, chances are that most financial institutions will insist on an investment property loan. Lenders will often attach a Second Home Rider to the mortgage of vacation homes. The rider specifies only the borrower will use and occupy the property and will not include it in a timeshare arrangement or rental pool.

So always make sure you understand the terminology and make it clear to the lender how you intend to use the property. This will ensure that you are given the correct loan and will avoid further trouble down the line.

Compare Financing Options For your Vacation Home

Are you ready to purchase the incredible vacation home of your dreams? A place where you and your family and friends can escape and spend quality time together away from it all. Weigh the financing options we have covered to find the best solution for you.

You can choose from conventional loans, home equity loans, HELOCs, piggyback second loans, or maybe a combination of them. Don’t let your dream vacation home be just a dream, check out a variety of lenders and the terms they offer on the compare and review page.