Vacation Home Finance Tips
Vacation home sales have increased in recent years. Many people, drawn by low interest rates, are choosing to pick up a second property. However, while vacation home loans can be cheaper than they were in the past, it may also be more difficult to qualify for these type of loans.
Because of this, vacation or second home buyers may want to explore alternative types of financing.
As always, ask your lending professional what options make the most sense for your specific situation.
Qualifying for a Second Mortgage
Mortgages are usually available for second homes, but they may be tougher to get if the buyer already has a mortgage on their primary home. Buyers typically need to stay within the debt to income limits that are required by Freddie Mac and Fannie Mae. That means that total housing payments for two mortgages can't be more than 28% of monthly gross income in most cases.
In addition, the total of all debt payments usually cannot go over 36% of gross income. However, a higher down payment can reduce the buyers monthly mortgage payment, which might be enough to get under the limits.
If, however, a traditional mortgage still won't work, listed below are a few of the options that might be available for the vacation or second home buyer:
Home Equity Line of Credit
In 2012, nearly half of all buyers of second homes paid in cash or put 20% or more down. The most common source of funding at that time were home equity lines of credit from a first home. Since this is secured by the equity in the first home, it may be easier to get than a mortgage on the new second property.
If the vacation home or second house may need some improvements or repairs, a construction loan might help make the purchase and repairs - if you qualify. Construction loans usually require a detailed plan with projected costs and a schedule for completion.
Bridge loans are, in most cases, short term loans for initially purchasing the property. The buyer will typically need to refinance the bridge loan into a more permanent mortgage. Expect to pay a higher interest rate, though, in some cases, your interest on the home may be tax deductible.
Periodically Renting Out the Vacation Home
If you rent out the vacation or second home for 14 days or fewer during the year, you don't have to report the rental income on your tax return. And there s also no limit to how much you can charge - this is because the home is considered your personal residence. As a result the deduction of mortgage interest and property taxes is the same on this home as the primary home.
However, if the buyer plans to use the vacation home for more than 14 days or more than 10% of the number of days it is rented, whichever is greater, it is then considered a personal residence. However, if the buyer limits their personal use to 14 days or 10% of the time the vacation home is rented, the home is then considered to be a business. Rental expenses can be deducted up to the level of rental income, but losses are usually not allowed. The rental price will usually need to be high enough to cover both the mortgage and taxes on the home.
Those with a lot of equity in their current homes may choose a reverse mortgage as a way of financing a second home. With a reverse mortgage, payments are made to you based on the equity built up in your house. These funds are usually yours tax-free and can be used for any purpose.
Reverse mortgages are limited to people who are 62 or older and who own their own home. The total amount available is based on your age, the value of your current home and the current interest rates at the time you apply.
Funds from an IRA
There are very specific rules for using an IRA to buy a second property. Typically, a home buyer will not be able to use a traditional IRA to purchase a primary home - without paying penalties for early withdrawal. An IRA that is invested in real estate, including a vacation or second home, will likely have to be a self-directed IRA.
It is advisable to talk to both tax consultants and personal finance advisors before looking at IRA funds for a second home purchase.
Funds From a Whole Life Insurance Policy
Whole life policies gain monetary value over time as payments are made into them. As a result, owners of whole life policies can often borrow from such policies to pay for a second home. This can save you from having to go through the process of qualifying for a mortgage. However, you will eventually have to pay back the loan if you still want the original amount of the death benefit to be paid out on the policy.
If the owner of the property is open to offering financing themselves, you may be able to avoid getting a mortgage from a bank. However, there may be a few hurdles to be negotiated first. The current owner must usually own the home outright. Additionally, the owner of the home selling it to you may request a higher interest rate than a traditional mortgage.
Creative and motivated vacation and second home buyers can often find a number of options that will allow them to own a second home. Talk to your real estate agent and financial advisors to see what alternatives might make it easier for you to buy a dream vacation home.