Buying a second home can bring forth a wealth of personal and financial benefits. For example, if you purchase a vacation property or getaway, you can spend more quality time with friends, family — or just yourself.
Plus, your second home could appreciate in value while you enjoy it, becoming a valuable asset over time. You could even take advantage of the Airbnb boom and earn rental income if you decide to put your second property to work while you’re not using it.
While the benefits sound enticing, it’s important to know about the tax implications and financial responsibilities of owning a second home. Keep reading to find out what you need to know before bidding on that mountain chalet or beachside bungalow you have your eye on.
- Know How Much You Can Afford
- Plan To Have Extra Cash in Reserve
- Your Credit Score Matters A Lot If You’re Buying a Second Home
- Be Prepared With a Large Down Payment
- Be Aware of Taxes
- Frequently Asked Questions on Buying a Second Home
For a vacation home that won’t be rented out, most buyers can finance up to 90% of the home’s value, according to Fannie Mae. However, buyers will still need to consider all their other outstanding monthly debts, including the payment for their primary residence and the cash left in the bank — known as reserves — after the transaction is complete.
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If you plan to finance your second home, have cash stashed away. You already know you’ll need to have enough funding for a down payment. Most banks also require homebuyers to have at least two months’ worth of PITI (principal, interest, taxes and insurance) in the bank, after you’ve accounted for the costs for the new home settlement.
Just like when you bought your primary home, your credit score affects what rate you can get for your second-home mortgage. There’s more — the lower your credit score, the higher the down payment you’ll need. Plus, you’ll have to show you have less debt than someone with a better FICO score.
You’ll need to put 25% down on a second home if your credit score is 680 or less, and your debt to income ratio is under 36%. If you carry more debt (between 36% to 45%), your FICO score needs to be at least 720, and you’ll need a 25% down payment.
If you’re planning to finance a vacation home, a 10% down payment will usually suffice, so long as you meet the other mortgage criteria — and you purchase private mortgage insurance.
If you’re looking to rent your home, even just some of the time, it will be categorized as an investment property. Mortgage-lender requirements can be more stringent for investment home loans, requiring at least a 15% down payment.
Different tax rules apply, depending on how you use the second home. If you rent for zero to 14 days per year, you’re not required to pay federal taxes on the rental income, according to the IRS. If you rent the home for more than 14 days, you’re required to report all rental income, although you can deduct rental expenses for when the home is rented out.
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Are you wondering if a second home could work for you and your family? Here are some frequently asked questions you should ask yourself if you’re thinking about buying a second home.
You’ll need to put at least 10% down on a second home, according to Fannie Mae. But if you want to avoid having to pay for private mortgage insurance every month, your best bet is to put 20% down. The larger down payment could save you mortgage insurance fees over the life of the loan.
If you dream of having a vacation getaway for you and your loved ones, you’ll need to take the following factors into account before you buy:
Credit score: Banks will want to see a higher credit score for your second home purchase. Fannie Mae’s minimum credit score for a primary home loan is 620. The lender requires a larger 25% down payment for homebuyers in that FICO range.
For a second or vacation home, the minimum FICO for the same down payment is 640. If your credit history has its challenges and your score is hovering around the minimum 640, get ready to pay a 25% down payment or more to secure that second home.
Income and debt level: You’ll need to make enough money to cover the costs of your household. To know if you make enough, calculate your debt to income ratio. For example, if you and your spouse make $12,000 per month combined, and all your mortgage, car loans, other loans such as personal loans or student loans, and potential second home mortgage add up to $4,000 per month, your DTI level is 33%.
With this DTI, you can qualify for a second home mortgage in both the lower and higher credit score threshold. Fannie May allows a DTI of up to 45% of your gross income.
Cost of the property: Most standard conforming loans are capped at a maximum of $510,400 for most areas. But the maximum amount may be higher, depending on the location of the property. High-cost areas have a higher ceiling loan limit of $765,600.
If you need to finance a second home for more than the limit, you’ll have to look into a jumbo loan. Jumbo loans tend to be more expensive and require an excellent credit of 740 or higher and a larger down payment. If you’re not ready to dive into jumbo loans, it’s best to start with a more affordable vacation home.
Buying a second home works much the same way as buying a first home. The main difference will be the requirements. You’ll need to show you can afford both homes, based on your income. It’s also likely that you’ll need a higher credit score to qualify. If you want to buy a second home, ensure your finances are in order, your debts are paid off and that your FICO score is as high as possible.
Looking To Invest?: Here Are the Best Places in Every State To Get a Vacation Home
Buying a second home could be a good investment if you do your research. Just like the search for your primary residence, choosing a home in a high-demand area could increase your investment over time. And if you rent your second home as a vacation property, you will earn income on it when not in use, which is a win-win.
Click through to find out about 11 overlooked cities prime for buying a vacation home.
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