There are plenty of reasons to want a second home. Whether you’re making the leap into real estate investing and need a property that can cash flow each month or you just need a place to stay in the summers, second homes are a mainstay in the classic “freedom” lifestyle.
However, buying another property is a serious financial commitment. And if buying a primary home is one of the largest financial transactions you are likely to make, purchasing a second home can be just as large. Therefore, before buying a second home, it makes financial sense to calculate if you can afford the purchase costs and maintenance.
So, whether you want to find the perfect beach getaway, commuter home near a major city, or rental property to start a real estate portfolio, you need the best advice on how to buy a second home.
This article explores the necessary steps to take ownership of a second residential property. You will learn how to choose a location, find financing, and close a deal.
When is a Second Home a Good Investment?
Buying a home in addition to your primary residence has several financial benefits. We’ll list them below.
Renting your second home as a short-term rental during the times you’re not staying there or as a long-term rental is a great way to get started in real estate investing and start building cash flow.
Although the property market experiences ups and downs, general trends show that property values appreciate in the long term. This means you can expect a healthy rate of appreciation over the long run, quietly building your net worth.
Buying a second home means you have access to several tax benefits, thus reducing how much you owe to the IRS. For example, you may qualify for a mortgage interest deduction or property tax deduction.
However, getting sound financial advice is wise before considering a second home for tax purposes. Property tax laws on real estate investments can change. And depending on the number of days you occupy the additional property, the IRS could consider it a second home or an investment property, each with different tax implications.
How Many Homes Can You Afford?
Before buying a second home, it is crucial to assess your financial situation.
For example, you may need to qualify for a second-home mortgage. Having enough income and savings to cover unexpected expenses is also good. For example, what will you do if you have extended vacancies? Can you still pay the mortgage if interest rates rise? There are also additional expenses to consider with owning a rental property.
Mortgage lender requirements for a second home
Mortgage lenders typically require higher down payments for a second home, higher minimum credit scores, and will give higher interest rates.
It’s recommended that you have a down payment of more than 10% and plenty of cash on hand. There are also many lenders that will require you to live in the property for at least part of the year.
Calculate debt-to-income ratio (DTI) requirements
Mortgage loan approvals always depend on debt-to-income ratio requirements. For example, if you are buying a second home, you will typically need a DTI below 45% to get pre-approved for a second home mortgage.
Here is a quick way to calculate your debt-to-income ratio:
- Add up your monthly bills, including mortgage payments, credit card payments, and other debt payments.
- Divide the amount by your gross monthly income (pre-tax income).
- The result is a percentage showing your DTI — the lower the number, the less risky you are to mortgage lenders.
Vacation home vs. investment property
Knowing the difference between having a vacation home or an investment property is crucial. For example, tax benefits, financing, and mortgage options differ depending on your home use.
Generally, a vacation home is one you have for enjoyment purposes or live in the property for ten percent less time than it’s rented. On the other hand, a second home becomes an investment property when tenants occupy it for most of the year.
How to Buy a Second Home
Buying a second home requires the same due diligence and financial calculation as when you bought your primary residence. However, running costs, mortgage options, loan payments, and maintenance can be significantly higher than your current home.
Consider all the costs of buying and owning a second home
It’s vital to crunch the numbers before you commit to buying a second home.
Here are some of the expenses to consider:
- Property taxes: You will have to pay taxes on a secondary property like a primary residence. However, depending on your tax status, you may qualify for a property tax deduction.
- Maintenance: Maintaining a second home can be relatively costly because you typically rely on third-party contractors. For example, a property management company, lawn services, emergency repairs, and upkeep impact your income stream.
- Utilities: Long-term tenants typically pay for utilities as part of the lease agreement. However, for short-term rentals of vacation homes, you must calculate the cost of energy bills. For example, in the winter, an ambient indoor temperature is necessary to prevent issues with dampness and mold.
- Insurance: Insuring a secondary home costs more than your main residence. Also, depending on the type of property — vacation home or investment property — you have to choose between different insurance options. For example, hazard insurance might be necessary for some beach resorts. And insurance for rental properties is more expensive than for a second home.
Explore your financing options
Successful real estate investing depends on getting the right financing options. But the mortgage qualifications for a second home will be stricter than your current mortgage. Also, loan options depend on specific credit score requirements for investment properties or vacation homes.
A jumbo or conventional loan is the two most common financing options when purchasing a second home.
- Conventional loan: To qualify for a conventional loan, you must meet the income and down payment requirements stipulated by Freddie Mac and Fannie Mae and within limits set by the FHFA (Federal Housing Finance Administration). However, there are two restrictions with this type of loan regarding second homes:
- You must have a credit score of at least 620. However, the higher, the better to get the best interest rates.
- You cannot rent your home for more than six months in the year; otherwise, it is classified as an investment property.
- Jumbo loan: Also called a non-conforming conventional mortgage, this loan option can be useful to finance a real estate purchase. Here are some requirements for getting approved for a jumbo loan:
- A credit score of at least 700 (some lenders stipulate a minimum 720 credit rating).
- A debt-to-income ratio below 45%.
- Some lenders require you to have enough cash to cover 12 months of mortgage payments.
Get pre-approved for a mortgage
Getting pre-approved for a mortgage early in your real estate investment journey is vital. Preapproval lets you know how much you can afford to offer for a second home. Additionally, the financing process proceeds much faster when closing a real estate deal.
Perform market research for potential housing markets
As with any real estate investment, due diligence is crucial when buying a property home for rental or as a second home. Therefore, you must conduct thorough research on housing markets with solid investment potential.
Here are some top tips on finding the right type of property:
- Decide if the property is for rental, your second residence, or a mixture of both.
- Analyze current market trends in the local area you are considering.
- Research neighborhoods for quality of life, amenities, and proximity to key facilities.
- Look at five or six comparable properties to find the best deals.
- Calculate the average price of the comparable properties.
The next step in the house-buying process is to find a local real estate agent to find your ideal second home.
Find a reputable real estate agent
An experienced real estate agent is invaluable when buying a second home. They will cover all bases to scout out the best deals for your needs — which is crucial if you are buying a property in another state. They can also handle the initial negotiations with the seller, saving you travel costs and time.
A good estate agent is still useful even when buying a second property in the local area. This is because they can find the ideal property for your lifestyle requirements. For example, the type of suitable property depends if you plan to buy a second home or investment property. Or do you want to move to your new home and rent your existing property? In these cases, a local real estate agent’s services are vital.
To find a good, qualified real estate agent, use our Agent Finder tool!
Once you have found your dream home, it is time to make an offer. You can work out your negotiation strategy and how much to offer with your real estate agent. This includes contingencies in the sale agreement and how much earnest money (down payment) you can afford.
Whether you offer below the listing price or meet the buyer’s price depends on if the house value is fair and how much you want the property. But, again, your real estate agent can guide you through the process.
If the buyer accepts your offer, you then start the process of closing the deal. If the buyer counteroffers, you will have to negotiate how much you are willing to spend.
It can take 30 to 45 days to close on a house. However, it can be longer depending on issues in the mortgage application, home appraisal, and home inspection. During this period, the closing agent carries out all the necessary tasks to transfer property ownership from buyer to seller.
Here are the necessary steps when closing on a property deal:
- Open an escrow account: Typically, your real estate agent opens the account where the deposit, earnest money, and the money from the lender are held.
- Find a closing agent or real estate attorney: Some states require you to hire a real estate attorney to close the deal and file the paperwork.
- Title search and insurance: This step confirms the property’s legal ownership. Insurance protects you and the lender from title defects, liens, or encumbrances.
- House appraisal: Your lender arranges an appraisal of the property to ensure the value is accurate. A value lower than the listing price may affect how much money you can borrow. Therefore, you may have to negotiate a lower sale price with the seller.
- Home inspection: Getting a home inspector’s report lets you know the property’s true condition. Typically, the sale contract contains a contingency agreement allowing you to back out if serious structural or other major issues are discovered.
- Final walk-through: You and the agent can walk through the property — usually 24 hours before closing — to ensure everything is ready to sell. You check that all repairs are completed, the property is damage-free, and it’s clean.
- Closing day: The big day has arrived for you to become the legal owner of a second home. You pay closing costs and additional fees on closing day and sign all the paperwork. Lastly, the closing agent arranges for the seller to receive money from the escrow account.
Buying a second home is an exciting process and can be a wise financial move. However, to ensure the second home fits your lifestyle requirements, if vital to remember the following aspects:
- Decide on the reason for buying a second property — is it a vacation home or an investment property?
- Ensure you have the financial means to buy and maintain a second home.
- Carry out due diligence every step of the way to get the best mortgage loan, find a good estate agent, and find a property that matches your financial goals.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.