Finance_Vacation_Home

How to Finance a Vacation Home

Do you dream of buying a vacation home? Whether it’s a beachside cottage or a mountaintop cabin, you can make your dream a reality. Just 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?

Financing options for vacation home

There are two paths you can take to finance your dream vacation home. You can take out a conventional second mortgage loan at a bank. Or you can take out a home equity loan or home equity line of credit (HELOC) on an existing property.

Let’s dig deeper into what each of these routes entails.

Conventional loans

You can apply for a conventional second mortgage loan from banks and credit unions across the country. The process will be similar to paying a mortgage for a primary residence. You will be asked to put down an initial down payment, and then will set up a payment plan over a span of 15-30 years. These loans can come with either fixed or adjustable interest rates.

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

What are the differences between a conventional loan for a second home and the mortgage for your primary residence? Second home loans require a larger down payment — typically between 10 and 30%. They are also harder to acquire. If you want a second home loan, you’ll need a high credit score, high income, and a strong debt-to-income ratio. You’ll also need to prove that the residence will be a vacation home and not an investment property. In other words, if you intend to rent it out, you’ll be disqualified from a second home mortgage. If this is your plan, look into investment property financing instead.

Let’s look at an example: Quicken Loans.

Quicken offers two different second mortgage loans: a 30-year loan with fixed rates of 4.125%, and a 15-year loan with an interest rate of 3.25%.  requires a down payment of as little as 10%. It offers pre-approval, which gives you some leverage when negotiating rates. To secure a Quicken loan, you’ll need to make a down payment of as little as 10%.

Curious about your other options? Compare and review providers here.

Home Equity

Your second option is to borrow from your existing property’s equity. There are a couple of ways to go about this.

The most popular option is to take out a HELOC — a line of credit backed by the equity you have in your home. If you take this route, your primary mortgage will stay the same. The HELOC will count as a separate loan. However, HELOCs usually offer variable interest rates, which can be risky in the long run. They also require good to excellent credit scores.

Home equity loans are another popular option. These loans are also backed by your equity in your home. They provide your funds in a lump sum (rather than providing a line of credit that you can draw from and pay off repeatedly). Home equity loans generally have fixed interest rates.

If your home’s value is on the rise, you could also consider refinancing your existing mortgage into a bigger loan. You can spend the difference on your second property. You may also be able to renegotiate a lower interest rate.

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

Blackhawk’s HELOC offers you access to up to 90% of the value of your home. However, you’ll need to qualify with an excellent credit score, and interest rates are variable.

Want more options? Compare and review a range of HELOC lenders.

How to afford your down payment

Many buyers want to buy a second home with no money down. Unfortunately, while there are zero-down payment options for primary residences, these routes are not available in the U.S. for a second home.

So you’ll have to make a down payment. But how can you keep it affordable?

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

Next, figure out where you’re going to get the money. The National Association of Realtors® confirms that around one-fifth of buyers use equity from their main residence to finance the down payment on their second home. A HELOC can help you put money down without having to draw from your savings.

You can also consider a Purchase Money Second Mortgage, also sometimes called a ‘piggyback’ second mortgage. As the name suggests, this is a HELOC or home equity loan taken out at the same time as your initial mortgage. Interest rates on these loans are generally variable, but they will provide that extra cash you need for your down payment.

Vacation home loan requirements

Now that you know what financing options are available, let’s look closer at what you’ll need to secure one.

Good credit

A good credit record is essential. You’ll likely need a score of 650 or higher to qualify. Of course, the higher it is, the better the chance that lenders will approve your loan. A higher credit score can also help to secure better overall terms.

If you are unsure of your credit record, you can always check it before you apply. You can check your credit report and score here for free.

Ability to make a down payment

Be ready to have your down payment of 10%-30% on hand or have a plan for how you can get it. And here’s a tip: the more you can pay down up front, the better interest rates you can secure for your loan. If you put down over 20%, you can avoid paying private mortgage insurance (PMI) premiums. PMI is an insurance that protects the lender if you stop making payments on your loan.

Qualifying savings

You don’t only need enough cash to make a down payment — you’ll also need savings 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. This will vary based on the lender and your profession.

Low income-to-debt ratio

Lenders will also check your debt-to-income ratio. They’re looking for a ratio of 43% or lower, both for your main home as well as the vacation home you intend to buy. This means that the cost of your total expenses (your mortgages, taxes, car payments, any other loans or household debt) must not exceed more than 43% of your total income.

Be ready to show at least two months of bank statements, two years of tax returns, two years of W-2’s, one month of pay stubs and investment properties owned, records for retirement accounts, social security, pension award letters, and two years of 1099s.

Proof it’s a vacation home

If you intend to rent out your second home, even for a small percentage of the time, many lenders will not give you a vacation home loan. This is because mortgage rates for a second home differ from those for investment properties. If you plan to vacation in your property over the summer but rent it out at other times, most financial institutions will insist on an investment property loan.

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 receive the correct loan, and will avoid further trouble down the line.

Compare financing options for your vacation home

Ready for your dream vacation home? You’ve got a lot of options to finance its purchase — just be sure to do your research. Compare and contrast HELOC lenders, home equity loans, traditional mortgage loans, piggyback second loans, or some combination of the above. With the right financing option, you can make that dream a reality!