Are you in the market for a second home? Whether you plan to use it for leisure or rent it out to earn income, you’ll likely need to secure a mortgage if you can’t afford to pay cash. The mortgage process is similar to that of your first home, but there are also key differences to be aware of.
In this guide, you’ll learn more about how second mortgages work, as well as lending guidelines and important considerations to keep in mind before formally applying with a lender.
Introduction to Second Home Mortgages
As the name suggests, a second home mortgage is a type of home loan used to purchase an additional property.
What is Considered as a Second Home?
You may think of a second home as a property you purchase on top of your current one. However, the Internal Revenue Service (IRS) is a bit more detailed in categorizing these properties. The title applies if you live in the home for more than 14 days annually or more than 10% of the number of days you rent it out.
Is It Difficult to Get a Mortgage for a Second Home?
Lenders face a higher risk of default with mortgages on second homes. So, the requirements are often stricter compared to mortgages for primary residences. Expect to meet more stringent credit and down payment criteria. The underwriting process may also be a bit tougher to ensure you’re a good fit for an additional home loan.
The Implications of Not Meeting Second Home Mortgage Requirements
Failing to meet the lending guidelines yields two outcomes. You could be denied financing and forced to search for other lenders. You could also find a lender with more flexible criteria, but you may not qualify for the most competitive terms it offers.
What are Your Options for Second Home Mortgages?
You have several options to choose from to finance the purchase of a second home.
Conventional loans
These are relatively common options for purchasing second homes, but they require a down payment of at least 10 to 20%. A good or excellent credit score is also preferred to qualify for the best financing terms. Lenders also look for a debt-to-income ratio of 43% or lower.
Jumbo loans
If you want to purchase a second home exceeding the conforming loan limits set by Fannie Mae and Freddie Mac, you’ll need a jumbo loan. You’ll also need a steeper down payment – usually 20% or higher – and a strong credit profile.
Home equity loan
If you have a sizable amount of equity in your primary residence, you can take out a home equity loan to fund your second home purchase. You can use the loan proceeds as a down payment or purchase the property outright, depending on the amount you access. This type of loan also typically comes with a fixed interest rate, giving you predictable monthly loan payments that are easier to manage.
Home equity line of credit (HELOC)
A HELOC lets you convert your equity into cash, like a home equity loan. You can use it to put a down payment on your second home. Unlike home equity loans, HELOCs come with revolving interest rates and payments that fluctuate over time. The upside is you can control borrowing costs, as you’ll only pay interest on the amount you draw from the revolving credit line.
Cash-out refinance
A cash-out refinance involves refinancing your current home for an amount larger than you owe and receiving the difference in cash. The overage is based on home equity, and you can also use it to fund your second home purchase.
Understanding Second Home Mortgage Requirements
Once you’re familiar with the types of loans available to buy a second property, take some time to understand the lending guidelines.
Credit Scoring and Its Importance
Most lenders prefer a credit score of at least 620 to qualify for a mortgage to purchase a second home. This is the minimum threshold, though, and it could be higher, especially if you’re considering a jumbo loan.
Also, be mindful that a higher credit score generally means you’ll qualify for the most attractive loan terms. So, it’s worth tuning up your credit score if it’s on the lower end before applying to potentially save a bundle in interest over the life of the loan.
The Role of Income in Mortgage Approval
Timely payments from borrowers are at the top of the priority list for any lender – it’s the lifeblood of their business. Consequently, lenders require you to prove you have a steady employment history and the ability to make timely monthly loan payments.
Details on Down Payment
Expect to put at least 10 to 20% down to get a mortgage for a second home purchase. If your credit score is lower or if there are other concerns, the lender may require a down payment of up to 30%.
Debt-to-Income Ratio: What It Is and Why It Matters
Lenders also assess your debt-to-income ratio (DTI), which represents the percentage of your monthly gross income allocated to monthly debt payments. Ideally, it should not exceed 43% to have favorable approval odds. However, other compensating factors, like a strong credit score or large reserves, could convince the lender to be a bit more lenient.
How to Qualify and Get a Second Home Mortgage
When you’re ready to apply for a second home mortgage, here are some tips to prepare your finances.
Evaluating Your Financial Stability
Review your current spending plan and identify how much wiggle room you have for added debt. Limiting your purchase power to what you can comfortably afford to repay each month is vital, even if the lender approves you for a more substantial loan amount.
Improving Your Credit Score
If you’re not in a rush to seal the deal on a second home, it’s worth improving your credit score if it’s not on the higher end. Doing so could mean more favorable interest rates, terms, and thousands in interest savings over the loan term.
Increasing Your Income
A strong monthly income helps you look more attractive in the eyes of lenders. It also lowers your DTI, which could be the difference between an approval, denial, or qualifying for a higher loan amount.
Lowering Your Debt-to-Income Ratio
To piggyback off the last point, a lower DTI could be music to your lender’s ears. If possible, pay down your revolving debts (i.e., credit cards, lines of credit) to lower your monthly payment amounts.
Saving for a Higher Down Payment
A higher down payment gives you more skin in the game and minimizes the lender’s potential losses if you default on the loan. In most instances, 10 or 20% is the bare minimum, but putting down more could get you a lower interest rate.
Things to Consider Before Applying for a Second Home Mortgage
Beyond the basic eligibility guidelines, a few more factors must be considered before starting the lending process to acquire a second home mortgage.
Understand the Market
Get to know real estate trends in your area. If price points are trending upward, it could be in your best interest to hold off on purchasing a second home until they cool off a bit. Or you may want to explore options in other nearby areas that are a bit more affordable, particularly if you’re working with a tight budget.
Considering Secondary Costs of Home Ownership
Homeownership expenses span beyond the monthly mortgage payments. Be sure to account for property taxes, homeowners insurance, utilities and maintenance. If you live in a deed-restricted community, you could also be on the hook for HOA and CDD fees. Property management expenses should also be accounted for if you plan to rent out your home.
Choosing the Right Mortgage Provider
Some mortgage providers are more reputable than others, and exceptional customer service is an important part of the equation. It’s also essential to do business with transparent lenders offering competitive mortgage products. They should have experience originating second-home mortgages to help you navigate the process easily.
Conclusion: Key Takeaways on Second Home Mortgage
Financing a second home requires a thorough understanding of the lending landscape. Lenders generally perceive these loans as higher risk, so you’ll need to familiarize yourself with the guidelines and do your homework to ensure you position yourself to get the best deal on financing.
A strong credit score is vital, and you should have enough saved up to make a generous down payment. Also, pay attention to your DTI and aim to get it as low as possible before applying.
Most importantly, don’t let the stringent lending guidelines for second-home mortgages discourage you. Take the necessary steps to prepare your finances and make your dream of owning an additional valuable asset a reality.
