You’ve dreamed of owning a vacation home and are finally ready to make it a reality. Before researching lenders and applying for a mortgage, it’s worth understanding the pros and cons of these home loans. You should also learn about the options available and the guidelines accompanying each to find the best fit.
Keep reading to explore the specifics of vacation home mortgages, how they differ from primary mortgages and how the lending process works.
What is a Vacation Home Mortgage and How Does It Work?
As the name implies, a vacation home mortgage is a type of home loan used to purchase an additional property used for leisure or as a rental. The mortgage is backed by the home, which means making timely payments is paramount to avoid foreclosure.
Is It Harder to Get a Mortgage for a Vacation Home?
Lending guidelines are tighter and for a valid reason. Borrowers are more likely to prioritize monthly mortgage payments on their primary home loan, so the risk of default is higher in times of financial hardship.
How is a Vacation Home Mortgage Different from a Regular Mortgage?
Both are similar, but vacation home mortgages are exclusively for those looking to purchase a vacation home. The latter also acts as a second mortgage, and interest rates are typically a bit more steep.
You’ll generally need a good or excellent credit score and a higher down payment than you would for a primary mortgage. There’s also less leniency with the debt-to-income ratio (DTI) limit on vacation home mortgages.
The Advantages and Disadvantages of Vacation Home Mortgage
There are a few key benefits to financing a vacation home, along with drawbacks to consider before applying.
Advantages
- Lifestyle freedom: Acquiring a vacation home could give you the lifestyle freedom you’ve always dreamed of, and you don’t have to empty your reserves to seal the deal.
- Rental income: When you’re not using the property, you can rent it out to cover your monthly mortgage payments and possibly turn a profit.
- Tax perks: If you itemize deductions at a tax time, you might be able to lower your tax bill by deducting the interest property taxes paid on your vacation home mortgage.
Disadvantages
- Closing costs: Expect to pay closing costs between 2% and 5% on a vacation home loan.
- Maintenance expenses: There’s also the cost of property maintenance and repairs that could arise over time.
- Financial risk: It can be challenging to handle two mortgages simultaneously, especially when demand is slow and rental income is down.
What are Your Options for Vacation Home Mortgages?
If the benefits of taking out a vacation home mortgage outweigh the costs, the next step is to familiarize yourself with loan options.
Conventional Loans
It’s a more traditional option used to finance vacation home purchases. You’ll get a fixed interest rate, which means predictable monthly mortgage payments. That said, the minimum down payment is at least 10% to secure a loan.
Adjustable-rate Mortgage (ARM)
An ARM gives you a variable interest rate that starts out below the market rate for a set period and fluctuates over time for the remainder of the loan term. The primary draw is more affordable monthly mortgage payments to start. However, if you plan to own the property for some time, mortgage costs could increase exponentially unless you refinance to get a fixed rate.
Home Equity Loans
If you have a large amount of equity in your current home, you can tap into it through a home equity loan. Most lenders let you borrow between 80 and 85% of your home equity, and you can use the funds to make a down payment on a vacation home. Or you can buy the property outright if your loan amount is large enough.
Home Equity Lines of Credit
A HELOC lets you convert your home equity into cash like a home equity loan. It works like a credit card and gives you access to a revolving line of credit to pull from as needed during what’s referred to as a draw period. You only pay interest on the amount you borrow, making it easier to control borrowing costs. The interest rate is variable, so borrowing costs will fluctuate over time.
How to Choose The Right Vacation Home Mortgage
There’s no shortage of vacation home mortgages to choose from. But finding the right fit doesn’t have to be overwhelming. Start by making a list of lenders and making a note of their rates, terms, down payment requirements and other eligibility guidelines. Doing so makes it easier to narrow down your list of options when you’re ready to move forward.
What are the Requirements to Qualify for a Vacation Home Mortgage?
Although they vary by lender, here are some general guidelines to keep in mind.
Financial Requirements
Most lenders require a down payment of at least 10% to secure financing. It could be more in certain situations, so you want to have ample cash available to cover this amount and maintain adequate reserves.
Lenders also assess your debt-to-income (DTI), which represents the amount of your monthly gross income used to cover monthly debt payments. It should not exceed 43%, but you may have some flexibility here with excellent credit or if your income is on the higher end.
Credit History
You’ll also need a strong credit profile to get approved for a vacation home mortgage. Aim for a score of at least 660 to have the best chance of getting approved, although a higher score could mean more competitive loan terms.
Lender Requisites and Guidelines
Again, the specific requirements vary depending on the lender you select. However, you’ll likely need to provide documentation proving you’re employed with a consistent stream of income. Lenders want reassurance that you can afford a second mortgage payment on top of your other monthly debt obligations.
What are the Possible Rates and Terms for Vacation Home Mortgages?
Expect slightly higher interest rates than you’d pay for a primary home purchase mortgage. However, rates vary by market conditions and your financial profile, so it’s challenging to know exactly what rate you’ll get without getting prequalified with a lender.
Regarding loan terms, the repayment period ranges from 15 to 30 years on most vacation home mortgages. An extended term generally means more affordable monthly mortgage payments, but you’ll pay far more in interest over the life of the loan. But if you opt for a shorter term, you’ll own the home outright faster and could snag a better interest rate.
The Process of Applying for a Vacation Home Mortgage
Here’s step-by-step guidance to help make the lending process more seamless:
- Step 1: Evaluate your financial situation. Take a look at your debt load to determine how much disposable income can be allocated to an additional mortgage. If you plan to generate rental income, you can also factor it in. Also, assess your debt load and how it stacks up to your monthly gross income to compute your DTI. If it’s over the preferred 43% threshold, you may want to work towards lowering it unless you have other compensating factors.
- Step 2: Explore lenders. Search for vacation home lenders with loan options that work for you. Create a shortlist and note the advertised interest rates, down payment requirements, loan terms and fees.
- Step 3: Get prequalified. Select at least three lenders from your shortlist and get prequalified. This will allow you to learn how much you can potentially borrow and with what terms.
- Step 4: Apply for a loan. Compare financing quotes and select the best option. Formally apply with your chosen lender and submit the financial documents the lender will need to process your application.
- Step 5: Receive the final approval. Once the home is appraised and the underwriting team finishes reviewing your file, you’ll receive a lending decision. If approved, satisfy any conditions that linger (if applicable) to get a clearance to close.
- Step 6: Close the loan. Schedule the closing with your lender and review the loan agreement. At closing, remit the down payment and closing costs to seal the deal.
Conclusion: The Impact of a Vacation Home Mortgage
Financing a vacation home could be a smart investment. You can use it to enhance your lifestyle while turning a profit. But there are both pros and cons to taking on a second mortgage. Be sure to understand your options and run the numbers to make an informed decision.
FAQs About Vacation Home Mortgage
Yes, you can rent out your vacation home when it’s unoccupied to earn money. That said, the lender may impose restrictions on the rental volume, and you might be required to occupy the property for a certain number of days each year. In some instances, projected income may also be included in the calculations used to determine if you qualify for financing.
Yes, interest rates are typically higher for vacation homes than for primary residences since these loans are riskier for lenders. That said, your credit profile, DTI, down payment amount and other factors influence the rate you receive.
