Whether it’s nestled between mountains, overlooking white sands along the beach or simply out in the middle of nowhere, a vacation home can be a great way to get away from the doldrums of your everyday routine.
As with most real estate properties, a mortgage is usually used to finance vacation property purchases. These mortgages function much the same as any other type of real estate financing, though there are a few key points to consider.
The nature of investing in a second property can have a tremendous impact on how you go about obtaining financing, and it could be more difficult to qualify for favorable rates. Here, we’ll go over a few of the main factors you’ll need to be aware of when purchasing a vacation home.
Typically, the upper limit that lenders will consider is 43% of your monthly income. If a mortgage would take you beyond that, it is highly unlikely that it will be approved.
This limit becomes especially important in the case of financing a vacation home since many people who do so will still have regular house payments to make. Adding a second house—and another mortgage— will increase the amount of debt they have, and it may disqualify them from a loan.
In order to increase their ability to pay back a vacation home loan, borrowers often rent out their second home a few days out of the year or make a higher down payment to keep the principal amount down. But renting the second home could have a negative impact on the type of mortgage you can obtain and the rate and possible other terms. And the new rental income provided by the property most likely could not be considered in the debt-to-income ratio because most lenders require a two year track record of income. See Usage ---Investment Vs. Residential Property section below.
In many cases, those financing a vacation home make down payments as high as 50% in order to keep the loan amount down. To afford this down payment, they often use a home equity line of credit, which will count toward their debt-to-income ratio but may still keep the overall amount they owe down.
At the very least, making a down payment of 20% on your vacation home loan will mean you won’t have to pay for mortgage insurance while still keeping rates to a manageable level. At least 10% is generally required to qualify at all.
First of all, certain loan programs do not allow you to rent the property out, so it may not even be an option. If it appears that a borrower will use the property more for renting than for personal use, then the mortgage would be tailored toward financing an investment property rather than a personal vacation home—and it will likely have higher rates to go with that.
When seeking a mortgage for your vacation home, you’ll want to be able to prove that you intend to use it as a vacation home. To do so, you may need to show that the vacation home is a certain distance from your primary place of residence, that you have no intentions to rent it out, and so forth.
Also, it’s typically best to avoid renting the house out if you don’t need to in order to afford your mortgage. If you do need to rent it out, there are a number of rules that will affect whether it will be considered a personal residence or investment property.
The distinction between residential and investment property is made under rules set forth by the IRS, namely the 14-day or 10% rule. Under this rule, a vacation home may be rented out for 14 days or fewer and still count as personal property. If you exceed that number, it may count as an investment property.
The exception to this is if you use the property as a personal place of residence for more than 14 days or 10% of the days it was rented over the course of the year, whichever is higher. So, if you rent your place out for 150 days out of the year, and then live in it for 16, the home would still qualify as personal property since you used it for more than 10% of the time it was rented out.
This distinction can have significant tax implications, so it is recommended that you consult with your tax advisor when considering purchasing a vacation home.
These factors will have an impact on what rates you qualify for and whether you’ll be able to comfortably afford your home away from home.
Ready to apply for your vacation home loan? Click here to apply online today.
If you are seeking financing for a vacation home purchase, contact First Bank & Trust Company today.
As with most real estate properties, a mortgage is usually used to finance vacation property purchases. These mortgages function much the same as any other type of real estate financing, though there are a few key points to consider.
The nature of investing in a second property can have a tremendous impact on how you go about obtaining financing, and it could be more difficult to qualify for favorable rates. Here, we’ll go over a few of the main factors you’ll need to be aware of when purchasing a vacation home.
Debt-to-Income Ratio
Among the differences between getting a mortgage for a vacation home and a traditional mortgage is the impact it will have on your debt-to-income ratio. This ratio is, put simply, the amount of debt you have compared to how much income you make each month. It’s used by lenders to determine whether you’ll be able to make house payments.Typically, the upper limit that lenders will consider is 43% of your monthly income. If a mortgage would take you beyond that, it is highly unlikely that it will be approved.
This limit becomes especially important in the case of financing a vacation home since many people who do so will still have regular house payments to make. Adding a second house—and another mortgage— will increase the amount of debt they have, and it may disqualify them from a loan.
In order to increase their ability to pay back a vacation home loan, borrowers often rent out their second home a few days out of the year or make a higher down payment to keep the principal amount down. But renting the second home could have a negative impact on the type of mortgage you can obtain and the rate and possible other terms. And the new rental income provided by the property most likely could not be considered in the debt-to-income ratio because most lenders require a two year track record of income. See Usage ---Investment Vs. Residential Property section below.
Down Payment
Vacation home loans are often considered higher risk than normal mortgages since they increase the amount of debt the borrower will have to pay back. For this reason, they may require higher down payments than regular loans in order to qualify, especially for borrowers with somewhat lower credit or a higher debt-to-income ratio.In many cases, those financing a vacation home make down payments as high as 50% in order to keep the loan amount down. To afford this down payment, they often use a home equity line of credit, which will count toward their debt-to-income ratio but may still keep the overall amount they owe down.
At the very least, making a down payment of 20% on your vacation home loan will mean you won’t have to pay for mortgage insurance while still keeping rates to a manageable level. At least 10% is generally required to qualify at all.
Higher Rates
Again, since a second home mortgage is considered to be higher risk than a primary residence mortgage, you will likely have higher rates to deal with. In most cases, this isn’t by very much, but if finances are looking a bit tight, it will still be important to take this into consideration when qualifying for financing.Usage—Investment Vs. Residential Property
One of the ways borrower try to offset the costs of their vacation home mortgage is by renting the property out during times in the year when they aren’t using it themselves. While this can help you qualify for a loan and make monthly expenses more manageable, it can also complicate things considerably.First of all, certain loan programs do not allow you to rent the property out, so it may not even be an option. If it appears that a borrower will use the property more for renting than for personal use, then the mortgage would be tailored toward financing an investment property rather than a personal vacation home—and it will likely have higher rates to go with that.
When seeking a mortgage for your vacation home, you’ll want to be able to prove that you intend to use it as a vacation home. To do so, you may need to show that the vacation home is a certain distance from your primary place of residence, that you have no intentions to rent it out, and so forth.
Also, it’s typically best to avoid renting the house out if you don’t need to in order to afford your mortgage. If you do need to rent it out, there are a number of rules that will affect whether it will be considered a personal residence or investment property.
The 14-Day or 10% Rule
The distinction between residential and investment property is made under rules set forth by the IRS, namely the 14-day or 10% rule. Under this rule, a vacation home may be rented out for 14 days or fewer and still count as personal property. If you exceed that number, it may count as an investment property.The exception to this is if you use the property as a personal place of residence for more than 14 days or 10% of the days it was rented over the course of the year, whichever is higher. So, if you rent your place out for 150 days out of the year, and then live in it for 16, the home would still qualify as personal property since you used it for more than 10% of the time it was rented out.
This distinction can have significant tax implications, so it is recommended that you consult with your tax advisor when considering purchasing a vacation home.
Qualifying for a Vacation Home Mortgage
It’s important to take into account your current debt, the value of the home you’re looking at, the amount you earn, your current credit score, and your plans for the property when looking to finance a vacation home.These factors will have an impact on what rates you qualify for and whether you’ll be able to comfortably afford your home away from home.
Ready to apply for your vacation home loan? Click here to apply online today.
If you are seeking financing for a vacation home purchase, contact First Bank & Trust Company today.