Lots of things are better in twos: heads when making decisions, aces at the blackjack table and houses. That is, if you can afford two of them.
Sometimes the good stuff comes in twos by accident.
Cheryl J. owned a lovely two-bedroom condo in Las Vegas. When she married and got pregnant (with twins!) she and Jack decided to purchase a single-family home with a yard for the kids. Because the market was depressed, they kept the condo, renting it out.
Whether you decide to purchase a second home for a vacation retreat or to make some extra income, if you can afford it, it’s a great investment.
Can You Afford to Buy a Second Home?
If you’re less-than-wealthy, you’ll need to crunch some numbers to ensure you can truly afford a second home. Remember: it’s not just the purchase price that needs to be affordable. Plan on the same ongoing expenses with this house as you have with your primary residence: taxes and insurance, for instance.
For second homes, not just the purchase price needs to be affordable.
Then, factor in the additional expenses involved with owning a home that you don’t live in full-time, such as hiring a property manager.
If you can’t charge enough in rent to cover the monthly expenses, you’ll need a cash reserve to help out. Financial managers recommend that you stash away enough money to cover a year’s worth of rental income and maintenance.
Qualifying to Buy a Second Home
Once you’ve determined that you can truly afford a second home, if you can’t pay cash for it, you’ll need a mortgage loan.
The qualifications for a mortgage on a second home are a bit more stringent than when purchasing your first home, according to the experts at Dow Jones’ Smartmoney.com. Plus, the standards for purchasing a vacation property versus an investment property are different.
The benefits of choosing to buy a vacation home, rather than an investment property, include:
- Guidelines for purchasing vacation homes are more lenient than those for investment properties.
- Down payment requirements are generally more relaxed.
- Interest rates are typically better.
Here are some of the ways getting a second mortgage loan is more difficult than securing the first:
Larger Down Payment
You will still need to come up with a larger down payment than you would were you purchasing a home you intend to live in – from 20 to 35 percent of the purchase price, depending on the lender.
Improved Credit Score
Lenders require a higher credit score for loans on second homes. Again, this varies by lender, but the general rule is that you’ll need your credit score to be in the 725 to 750 range.
Afraid that your credit score isn’t in this range? Shop around for the second loan because guidelines vary between lenders.
Better Debt-to-Income Ratio
Our friends at Bank of America point out that lenders will put the debt-to-income ratios of those looking for second mortgages under closer scrutiny than they would for borrowers on their first mortgage. You may not be accepted for a second mortgage if your debt-to-income ratio is above 36% of your monthly pre-tax income!
Is your debt-to-income ratio above 36%? Here’s how you can lower it:
- Pay down credit card, other debts
- Make major purchases with cash until you secure the second loan
- Increase income (if you can’t lower your debts, this is your only option!)
- Buy a less expensive home
- Increase down payment size to lower mortgage payments
The Second Home and Taxes
It’s a good idea to meet with an accountant before finalizing the paperwork on the second home. The deductibility of mortgage interest on your taxes relies heavily on whether the home is viewed as a vacation retreat or a business investment.
Important question: Is your second home a vacation or investment home?
If it’s truly a second home, and not a rental, you can deduct all of the interest you pay – up to debt of $1.1 million – if the debt is secured by both of your homes.
Renting out the home presents a different set of problems and benefits. If you rent out the second home for more than 14 days out of the year, the rental income must be reported to the Internal Revenue Service and you’ll be taxed on it. Rental expenses, however, such as management fees, are deductible.
Situations vary, so if you plan to buy a second home, be sure to seek tax advice from a professional.