How Second Home Mortgages Work
Buying a second home is a dream for many homeowners, one that can be made into reality by leveraging existing equity, paying a higher down payment and reaching out to a trusted lender who can guide them through the process.
Owning a second home has long been a lofty goal for many Americans—and understandably so: Given access to ample funds, who wouldn’t want an additional domicile to visit on the weekends, stay during summer months or lend to friends and family.
That said, addressing the needs of this narrow (yet expanding) demographic has not exactly been a top priority for most policymakers. Making homeownership affordable and accessible for first-time homebuyers remains the chief objective for many in the housing market. Accordingly, most information available overwhelmingly focuses on what can be done to transact single home purchases. The ins and outs of buying a second home—and taking on a second mortgage—are a little less clear.
One thing is for certain, homebuyers seeking to expand their real estate portfolio are looking for an affordable rate, a seamless process and smart, contextual guidance to help optimize their homebuying journey and save them time and money. To that end, we’re providing a little education and guidance of our own to help you navigate the world of second mortgage rates and second mortgage purchases. It’s our opinion that a well-prepared and informed consumer has the best chance to make smart decisions.
WHAT IS A SECOND HOME MORTGAGE?
As the name suggests, a second home mortgage is for individuals who already own a primary residence and have a first mortgage. A second home mortgage is an additional mortgage taken out to purchase your second home.
Mortgages to purchase a second home have stricter requirements than those that pertain to your primary residence. When you think about it from a lender’s perspective, more stringent vetting makes perfect sense: Two mortgages mean twice as much stress on your debt-to-income ratio. Because of this, lenders typically request higher down payments, tougher underwriting standards, and higher interest rates than what you will encounter on your primary residence.
Second Mortgages vs. Second Home Mortgages
A second mortgage taken out to purchase a second home is not the same as the more frequently used term “second mortgage.” Confusing, right?
A second mortgage is a loan that uses your current home as collateral, leveraging existing equity that can then be used for a variety of purposes, including renovations, debt consolidation, large purchases—and yes, even helping you purchase a second home.
A “second mortgage: in the form of a HELOC or a home equity loan describes a lien in the “second” position—second because the original mortgage on your home qualifies as your first mortgage. A second mortgage can provide funds for you to use as you see fit. Depending on the size of the loan taken out, these funds can be used as a down payment or to purchase your second home outright
According to the Consumer Credit Financial Bureau, the term “second” derives from the idea that if you can no longer afford your mortgages and your home has to be sold to pay off the debts, the newer loan is paid off second. This is due to the lien position.
As part of the mortgage process, a lien is placed against your property by your lender. This simply means they have the legal right to seize your property in the event you don't meet the terms of your mortgage agreement. The first lien position—first mortgage—is paid off first. A HELOC or a home equity loan would fall into the second position—to be paid off only after the initial mortgage is accounted for (if there’s anything left).
This order is not lost on mortgage providers. If there is not enough built-up equity to pay off both loans completely, the lender of your second mortgage may not receive the full amount owed. This increases loan risk for the lender and accounts for the stricter lending standards.
Let’s put these second mortgages to the side for now and explore our primary focus: second home mortgages.
Understanding What a Second Home Is
Historically, a second home has been defined as a non-primary residence usually reserved for recreational or part-time seasonal use. However, that concept has expanded over the years.
In the shifting world of modern employment, a second home can also be a place to live when work demands it—a part-time residence that you inhabit when visiting a remote/alternate work location.
Investment Property
Note: A second home is frequently confused with that of an additional real estate possession—an investment property. An investment property is purchased for the purpose of making money. These homes are expected to appreciate over time and (often) generate income in the interim through rentals. While buying this type of property might be considered a “second home” to you, in the eyes of the industry, it’s considered an investment property, a distinction that impacts the kind of mortgage you can obtain and at what price.
Conditions to Qualify as a Second Home
A second home can actually be rented out, too; but only for small periods of time. According to the IRS (an important arbiter for tax-related reasons), for a property to be considered a second home and not an investment property it must meet one of the following two conditions:
You use the home at least 14 days each year.
You use the home at least 10% of the days that you rent it out.
Second homes are also eligible for mortgage tax deductions; we’ll discuss this in more detail in a moment.
If your prospective second home is located in a state different from your primary residence, you’ll need to get up to speed with state and local taxes, zoning laws, and any number of state-specific real estate provisions. To transact the deal with confidence, you’ll need a trusted real estate agent and mortgage provider as well as a professional title company. Expect to do some serious due diligence.
How Does a Second Home Mortgage Work?
Distinctions matter. You will need to classify your home as either a vacation home (or part-time residence) or an investment property. The former provides access to lower interest rates while being classified as an investment property has been associated with higher interest rates, higher down payments, and heightened loan requirements. Note: Regardless of classification, your second home mortgage will be more expensive to procure than your first mortgage.
Classifying your Second Home as a Vacation Home or Part-Time Residence
You have to meet certain lender requirements to qualify for second home (vacation home) status under Fannie and Freddie guidelines. The main stipulations are as follows:
Residency: You must live in the home for at least a portion of the year and retain it for personal use and enjoyment at least half the year. Furthermore, it must be suitable for year-round occupancy. It must also be a single-unit property.
Proximity: Your home should not be located too close to your primary residence. Remember: it’s supposed to be a vacation home and close proximity to your primary residence might disqualify it from being considered a vacation home.
Functionality: The home can realistically function as a second home and is only one unit.
Rentals: It is permissible to provide short-term** rentals at the property, but in doing so the property can’t be part of a property management company or a timeshare agreement.
Second-Home Mortgages and Underwriting Standards
Debt-to-income ratio (DTI): Conventional loans backed by Fannie and Freddie typically require no more than 43% DTI (although as of 2017 borrowers identified as low risk may be eligible for loans with a 50% DTI). If you need a primer, DTI is essentially the ratio between your income and recurring debts. It’s worth noting upfront that it can be hard to stay under either of these DTI levels when you have two mortgages to pay. In those circumstances, borrowers will likely need to procure a nonconforming or jumbo loan.
Credit score: Credit score standards will vary from lender to lender, but Fannie Mae requires a minimum of 640 to be approved for its loans. This is higher than the 620 needed for mortgage loans on primary residences.
Down payment: While the “20% rule” has been increasingly abandoned in recent years when it comes to primary residences, many lenders will require 20% or even 25% down payment for a second home. This is when leveraging your existing equity through a HELOC or home equity loan can come in handy. You can also choose to do a cash-out refinance to obtain an improved rate on your first home while also providing funds. All of these loan options put much-needed cash into your hands, cash that can be used to pay for the higher down payment necessary to secure your second home.
Second-Home Mortgage Rates
If you meet the above criteria, you can expect to be considered for a second home mortgage. The rates provided to you will vary, but overall they will not be as favorable as those issued for a mortgage on a primary home. This is mostly due to the fact that lenders perceive an extra degree of risk in second mortgages. A higher down payment can have a positive effect here, but you probably shouldn’t expect the same attractive rates provided to primary home mortgages. Note: Second home mortgage rates will generally be lower than those for investment properties.
Tax Breaks for Second Homes
While your down payment and mortgage rates will invariably be higher than those you received for your first mortgage (all things being equal in the marketplace), you can reap important savings when purchasing a second home by taking advantage of certain tax breaks. Although the Tax Cuts and Jobs Act of 2017 made it harder to qualify for mortgage deductions, homeowners can still deduct the interest paid on up to $750,000 in mortgage debt. Those who purchase a second home can also take advantage of:
Property taxes
Rental expenses
Depreciation deduction (in some circumstances)
Note: Because each situation is different, homebuyers should consult a tax advisor for more information regarding their property to see if they are eligible for savings.
Can I get a second home mortgage via FHA or VA?
Note: While technically feasible under very rare circumstances (employer-mandated job relocation, a growing family that necessitates more space, co-borrowers seeking their own home) FHA loans. are generally not allowed to be used for the purchase of second homes. The Federal Housing Administration is in business to fund principal residences—not vacation homes or investment properties.
Details around VA loans and second homes are more complex and take longer to unpack. Suffice it to say, under some circumstances you can indeed procure a second home through the Veterans Administration, but it depends on your eligibility status and how much equity you’ve built up in your existing home (how much of the current mortgage you’ve paid off). Contact a trusted loan officer who can get you up to speed with the entire process and determine if a VA loan for a second home is the right choice for you.
Investment Property Qualifications
If you already have one home under mortgage and are buying a second one as an investment property, chances are that you will be asked to pay a higher down payment and confront higher interest rates than you would for a mortgage on a second home/vacation property. The exact details will depend on your lender. But either way, if you’re looking for a mortgage, it won’t come from the VA or FHA.
In general, lenders consider investment properties to pose a higher risk than loans for principal residences or even vacation homes. There is a belief that the renters who live on the property might potentially ignore maintenance issues or exacerbate existing ones. Also, in financially challenging times, lenders may worry that you’ll prioritize paying down your primary home over the investment property—a legitimate concern. To ensure the investment property is generating income (and therefore mortgage payments), a lender may even request to see a lease or rent schedule to prove that you are engaged in the process and planning to rent the property.
In Conclusion
The notion of a second home might seem like a far-flung fantasy to many people struggling to finance their first home. However, in a time of rising incomes where homebuyers increasingly prioritize additional space and flexibility, more and more people are looking into obtaining a second home. It’s usually the financing minutiae—and perhaps the mortgage process itself—that gives them pause.
The good news is that it doesn’t need to be a headache. By organizing your finances ahead of time, doing the requisite research, and reaching out to a trusted lender experienced with second home mortgages, you can elevate your confidence level and ensure yourself of an easy, seamless process.