Paying for the luxury if you want or need to own a second home doesn't have to be a prohibitive challenge if you have a plan. Make sure that your budget can handle the extra monthly payments and remember to leave room for routine maintenance, utility bills, and the possibility of major repairs. Then you must figure out how you want to finance the purchase.
Key Takeaways
- Make sure you not only have the money for the monthly mortgage and interest payments but also for property taxes, homeowners insurance, utilities, and other expenses.
- FHA-insured loans are great when you're buying your principal residence because they allow a small down payment and a middling credit score but you can't use them for second homes.
- Consider paying for your vacation home in cash or by getting a home equity loan on your principal residence if possible.
- Be prepared to make a larger down payment, pay more interest, and comply with stricter requirements if you apply for a standard loan.
Second Home Financing Options
An FHA-insured loan is a prime choice for many home purchasers because these loans require a down payment of just 3.5%. Lenders even offer these loans to borrowers with lower credit scores. Your score can be down to 580 or even less in some cases.
However, second-home buyers aren't permitted to use FHA loans for their purchases. These loans are limited to homes that are the borrowers' principal residence.
Be prepared to pay more upfront to get a loan to buy a vacation home. You'll also probably need a higher credit score and a better debt-to-income ratio than you would need for a mortgage for a primary residence.
Option 1: Cash
An all-cash purchase is the easiest method to pay for a vacation home if you can manage to save enough. A National Association of Realtors (NAR) survey of home buyers and sellers has indicated that 33% of surveyed buyers paid cash for their home purchases.
Option 2: Home Equity Loan
A home equity loan may be an option for homeowners who have substantial equity in their existing property. However, lenders are less willing to approve a home equity loan that drains too much equity from the principal residence because home values could decline. Lenders assume that homeowners will be more aggressive in keeping up with payments on their primary residence rather than a vacation home if they run into financial trouble.
Option 3: Conventional Loan
Conventional loans are an option for vacation homes but be prepared to make a larger down payment, pay a higher interest rate, and meet tighter guidelines than you would for a mortgage on your principal residence.
You'll typically have to meet higher credit score standards of at least 725 or even 750 to qualify for a conventional loan on a second home, depending on the lender. Your monthly debt-to-income ratio should be strong, particularly if you attempt to limit your down payment to 20%. All borrowers must fully document their income and assets for a second home loan because lenders will want to see significant cash reserves to make sure they have the resources to handle payments on two homes.
Vacation home loans often come with a slightly higher interest rate than primary residences. Lenders base pricing on risk and they typically feel that the borrowers are more likely to default on a vacation home loan than the mortgage on their principal residence.
Not all lenders will allow rental income to be considered for the loan qualification if you plan to rent your vacation home when you're not using it. Some will allow only a percentage of the rent payments as income and some will require a documented history that the home has been consistently rented.
Beware of Condominiums
Many vacation homes at beaches or ski resorts are condominiums. Lenders often require that no more than 15% of the condominium development owners be behind on their association dues. It may be difficult to obtain financing for a vacation home in a condominium development that doesn't meet this requirement. The lender will most likely charge a higher interest rate to mitigate the risk.
Don't Forget Closing Costs
Closing costs are those extras that you will most likely have to pay or at least contribute to when you close on your second home purchase. They can include title searches, appraisal fees, taxes, insurance, and commissions that are paid to the real estate brokers and agents involved in the sale.
You might dodge the commissions bullet if you're buying a property because the seller is typically responsible for paying these costs but it's not uncommon for sellers to increase the purchase price of their homes to accommodate this expense.
Real estate commissions have become enough of an issue that a lawsuit was brought against the National Association of Realtors (NAR) to seek compensation for some unfair issues. NAR settled the lawsuit in 2024 pending court approval. The association agreed to pay a $418 million settlement and to bar offers of broker compensation on the Multiple Listing Service. But compensation can still be negotiated privately.
Is a Reverse Mortgage an Option?
A reverse mortgage is effectively a home equity loan. It's cash paid to you based on the amount of equity you have in your primary residence but a good many additional rules apply. You can only take out a reverse mortgage on your primary residence, although you can use the cash for anything you like. These mortgages are reserved for homeowners who are age 62 or older.
What Is the Minimum Down Payment on a Vacation Home?
There's no universal rule or law but a minimum down payment for a vacation home is often at least 10% and that can increase to 15% or more if you plan to rent out the home when you're not using it.
Does Homeowners Insurance Cost More for a Second Home?
The National Association of Realtors indicates that homeowners insurance will also cost more on a second home. You can probably anticipate a 20% increase or even more if you rent the property out.
The Bottom Line
Affording a second home starts with saving some cash. You'll also want to pay down any debt before you approach a lender to review your options for a mortgage. Keep in mind that many of the rules are different for financing a home that you're not planning to reside in full-time. Certain ongoing costs will increase, not just those incurred at the time of purchase.
The rewards can be significant, however, particularly if you have to or want to travel to the same location frequently.
