Second Homes and Investment Properties
If you decide to take out another mortgage to pay for a second home, lenders will look carefully at your debt-to-income (DTI) ratio to determine whether you can manage two mortgage payments. A low DTI also works to your advantage because it helps you qualify for a lower interest rate on the loan. For second homes, lenders prefer a DTI below 36%.
If your DTI is high, you have several options. You can pay off more debt before buying another home, buy a less expensive home or increase the amount of your down payment. Some lenders want a down payment of 10-20% on second homes, potentially more if it’s purely an investment property.
When shopping for a second home loan, it makes sense to first talk with the lender who holds the mortgage on your primary residence. This is because you’re already doing business together and have an established financial relationship. However, you may find a better deal with another lender.
While many second-home buyers consider their purchase an investment, whether it’s considered an investment for tax and loan purposes is another story. Think about why you want to purchase the home. Is it exclusively for personal use, or do you expect to rent it out part of the year? Whether it’s considered a second home or investment property could make a big difference in your tax situation.
Home Equity Down Payment
You can take out a home equity loan (HEL) or home equity line of credit (HELOC) to make the down payment on your second home. Your first home serves as collateral.
Advantages of HELs and HELOCs as a down payment include the following:
- Because your savings remain intact, you’re free to grow that money by making investments, or you can use the money for other purposes, such as paying for college or buying a car.
- If the equity in your first home covers the purchase price of the second home, then taking out a home equity loan is likely to be a cheaper option than taking out another mortgage.
- You may be able to deduct the interest paid on home equity debt, up to $100,000. If you use cash, you don’t get a tax break.
Disadvantages of HELs and HELOCs as a down payment include the following:
- If the value of your first home decreases due to changing market conditions or other factors, the lost equity could put you underwater on your first home loan. Because you’d owe more on the loan than the home is worth, you’d have a hard time selling it without taking a financial hit if you needed to move.
- Both your first home that you used as loan collateral as well as your second home could be in jeopardy of foreclosure should you be unable to make loan payments.
- If you’ve only owned your home for a few years or the housing market in your area took a downturn, you might not have enough equity in your home to cover the down payment for a second home.
- You can’t borrow against your home again until this home equity loan is paid off.
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