You have worked hard enough in life that you decide you want to buy a second home. This is an exciting time! There is just something so different about owning a home you can vacation at rather than renting or staying in a hotel. The good news is the mortgage process is similar to the one you went through with your original mortgage. You have to show that you qualify for a second home or vacation home purchase with income, assets, good credit, and a decent debt ratio. The bad news is the restrictions will be slightly tighter because any second home poses a higher risk to the lender. You can expect to have harder credit score requirements; need a larger down payment; and to have cash reserves on hand as an emergency fund.
The Full Implication of a Second Home or Vacation Home Purchase
Looking at the big picture, it makes sense that you have to jump through more hoops to purchase a second home/vacation home. You will have two houses to manage. This means more than just the mortgage payment, though. You have to be able to afford the taxes, insurance, and maintenance on the home. Lenders also consider the cost of traveling and the year-round costs you have to cover when you are not physically at the home. When you purchase a home as a second home or vacation home, the lender does not consider it an investment. In fact, you might not be able to rent it out according to your agreement with the lender. This means you have to cover the costs – you cannot use rent to offset them.
Fannie Mae Guidelines
If you want to secure lower interest rates and standard costs, a Fannie Mae loan is the way to go. Fannie Mae is a bit more lenient with second home guidelines than they are for investment properties, but you have to meet the following requirements:
- The home cannot be located too close to your primary residence (this would signify an investment home rather than 2nd home)
- You have to prove you will live in the home for at least a part of the year
- It needs to be only 1 unit
- Access to the home must be available year-round
The lender needs to feel certain that you will not use the property as an investment. This is because second home purchases have lower interest rates and fees than investment homes do. Many people try to sneak an investment home purchase as a vacation home, but Fannie Mae prevents this. You will likely have to sign an affidavit stating you plan to occupy the property at least during a part of the year as your own home. If you rent it out, you could violate your mortgage contract.
Higher Credit Scores
Generally, lenders want “great” credit scores to qualify for a second home or vacation home purchase. This is because it is not your primary residence. If you have mediocre credit, you pose a higher risk. The lender will believe that if you find yourself in a financial bind, that you would default on your second home because you still have a place to live. It is much harder to default on the home you live in than the one you only visit periodically throughout the year. This is why Fannie Mae requires higher credit scores to ensure the solidity of the loan.
Lower Debt Ratios
Just as lenders want higher credit scores, they want lower debt ratios, too. You are taking on a sizeable risk by carrying two mortgages and two households. Because it is completely up to you to manage both payments, you have to be able to fit them into the standard debt ratio guidelines. You will have to include all of the following in your debts to determine your debt ratio:
- 1st mortgage payment (principal, interest, taxes, homeowner’s insurance, and PMI
- Mortgage on second home (principal, interest, taxes, homeowner’s insurance, and PMI
- Car payments
- Credit cards
- Student Loans
- Personal loans
It is a good idea to try to pay your debts down before you apply for a mortgage to purchase a second home.
Higher Down Payment
Another way the lender will offset the risk of financing a second home purchase is with a higher down payment requirement. Generally, you can put just 3% down and secure conventional financing on an owner-occupied property. If you want to purchase a vacation home, though, you may have to put down as much as 10 or 20 percent. The exact amount depends on the circumstances of your application. If you have great credit and a low debt ratio, the lender may accept just 10% down. On the other hand, if you have just okay credit and a decent debt ratio, they may require a higher down payment to offset the risk your loan poses.
Compensating Factors Help
As is the case with any loan, compensating factors increase your chances of approval. Compensating factors can look like:
- Cash reserves (the lender counts your reserves based on the number of months of mortgage payments you can cover with your assets)
- Low debt ratio
- High credit score
- Stable employment
- Income that increases year after year
- Clean credit history with no late housing payments
The bottom line is you have to show the lender you are not a high risk. If you want to qualify for a second home or vacation home purchase, you have to have positive attributes on your loan application. Going to a lender with a housing history blemished with late payments or with so many debts you cannot keep your head above water will not work. Instead, you have to show that you are not a risk. If you make your housing payments on time on your primary residence and even make extra payments, it can work to your favor. The lender has to take quite a risk to finance a home you will not live in year round. You have to be able to show them why you should qualify.