Can You Afford A Second Home?
Are your personal finances ship-shape to the point that you can afford to buy a second home? Even if you plan to collect rental income from the property, you’ll want to be sure it’s a purchase you can afford – particularly if it will remain vacant for several months a year.
Here are some financial factors to keep in mind before buying a second house.
Down Payment And Interest Rates
As with purchasing any new home, buying a second home will require a down payment and a mortgage (with interest, of course) – unless you plan to pay with cash.
In fact, a higher down payment for a second home is required. Why? Purchases of a second home are a higher risk for mortgage lenders because there’s greater chance borrowers will default on a second home (versus a primary residence) in the event of financial hardship.
The same logic can be applied to mortgage interest rates. To hedge against potential losses in the event of a mortgage default, there’s almost always a higher interest rate on a second home mortgage. To determine the terms of your loan for a second home, your lender will take a look at your credit score and history, current housing market conditions and your debt-to-income ratio (DTI).
Debt-To-Income Ratio Requirements
You’ll have to meet DTI requirements to qualify for a mortgage on a second home. DTI refers to the amount of debt you hold versus the amount of money you make. You can quickly calculate your DTI by adding up the monthly debts you pay and dividing by your monthly pre-tax salary.
Most lenders require a DTI of 43% or less to approve you for a second mortgage.
Monthly Budgeting
You may be approved for a second mortgage on paper, but you’ll want to crunch the numbers to see if an additional mortgage makes good financial sense. The best way to do this is by adding up all of your monthly payments and subtracting this number from your monthly net income. The remaining money is where your second mortgage payment will come from.
You might be counting on the extra income from renting to help balance out your second monthly mortgage payments, but you’ll still want to make sure you can afford the payment on your own if your property doesn’t rent as quickly as you’d like.
In addition, you’ll want to consider property taxes, homeowners association fees and general upkeep costs before making this decision to take out a second home mortgage.
Rental Maintenance
You’ll also want to be prepared for the cost of buying a rental property and the maintenance that comes with it. As both owner and possibly landlord, you’ll be responsible for handling all repairs and damages. This could mean paying a repair person for services, purchasing paint, buying new doorknobs and other home improvement products, or paying a lawn service to maintain the yard.
Save at least 10% of the yearly rent for upkeep and property management. For example, if your property rents for $2,000 a month, the annual rent would be $24,000. Therefore, you should save $2,400 in case of emergency repairs. Keep in mind, repairs could cost more or less than this estimate, so it’s always a good idea to have more money saved.
Step 1: Decide Where To Buy Your Second Home
Deciding where to purchase your next property is a major decision. Should you get a home close to your family? Or would you prefer one on a beach, in the mountains or in a city you love?
It’s important to discuss locations with your spouse and other family members who might need to be included in this decision. From there, spend time researching the best local neighborhoods. Partner with a local real estate agent who’s familiar with the areas you’re interested in and can help find the best property for you.
Step 2: Determine How To Finance The Home Purchase
The type of mortgage you qualify for will largely depend on how you’re planning to use the second property. Borrowers may have to meet different requirements when qualifying for a mortgage on a second home, because these loans are riskier for lenders. Second home mortgages may also have different interest rates than loans for primary residences.
Two of the most common mortgage loans to consider when purchasing a second home are conventional and jumbo loans. You’ll be required to make at least a 10% down payment on a conventional loan, and 20% or more on a jumbo loan. The specific income, credit score and DTI requirements can vary by lender and loan type.
You can’t finance the purchase of a second home with government-backed mortgages, like Department of Veterans Affairs (VA) loans and Federal Housing Administration (FHA) loans. These loans can only be used to purchase primary homes.
Keep in mind that your lender will only qualify a property as a second home if you occupy the home for a certain amount of time throughout the year (compared to renting the second home to tenants). If your lender (or the Internal Revenue Service) determines that the house is instead an investment property, you may need to meet a different set of requirements when applying for a mortgage.
Step 3: Get Preapproved For A Second Home Mortgage
Beginning the mortgage process as soon as you’re ready to start looking for a home is important for a few reasons. First, starting the process early will eliminate any financial obstacles during closing and can help you close on time with no surprises.
Second, getting mortgage preapproval early will give you a better idea of how much you can afford for a second home, which is helpful once you start shopping for houses.
You can shop around for local lenders or research options online. Rocket Mortgage allows you to finance your second home completely online and provides helpful tools to guide you through the process. The income verification process is also fast and easy, since Rocket Mortgage allows you to instantly verify your income with online documentation.
Step 4: Partner With A Local Real Estate Agent
Your real estate agent is the most important person in this second home process. They’ll work to find you the perfect home and negotiate on your behalf, and they’ll be there to guide you through the rest of the buying journey.
Be sure to look for an agent local to the area where you’ll be purchasing. They’ll know the intricacies of the real estate market better than a regional agent, which means they can offer advice on finances and neighborhoods to explore.
When you search for a REALTOR®, be sure to look for a buyer’s agent only. Working with a dual agent, or an agent who represents both you and the seller, can cause conflicts of interest.
Step 5: Find Your Dream Second Home
Your agent can help you find your dream second home after you’re preapproved for a mortgage. They’ll assist you in finding homes that fit your criteria (like the number of bedrooms, square footage, location, amenities, etc.) and will show you homes that fit your budget and preferences.
Once you’ve found the home you want to buy, your agent will work with you to make an offer with the selling agent and negotiate any counteroffers. The next step begins once your offer is accepted.
Step 6: Close On Your Second Home
When the seller accepts your offer, it’s time to begin closing on the home. The closing process takes 30 – 40 days, on average, and includes several steps:
- Choose a real estate attorney or closing agent. Depending on the state you’re closing in, you may need a real estate attorney to handle the settlement and closing paperwork. Your buyer’s agent can help recommend a trustworthy attorney to represent your interests.
- Buy homeowners insurance. You’ll need to confirm proof of your homeowners insurance at closing in order for your lender to release your funding. Shop around for local policies and be sure to review extra damage protection (flood, wind, hail, etc.) depending on your home’s location.
- Buy title insurance. You’ll also work with a title company to research any outstanding liens on the property and make sure it’s clear to buy. Your title company will issue title insurance to protect your purchase.
- Schedule your home inspection. Your home inspection is separate from the appraisal and does a more thorough examination of the property. You’ll work with your agent to negotiate with the seller on pricing or repairs if issues are found. If no issues are found, you’ll move on to the next step.
- Wait for appraisal results. Though you can do the appraisal before the inspection, the inspection will flag major issues before you spend money on an appraisal. Your lender will arrange for a home appraisal to ensure your home’s value is accurate. If the value is the same or higher than the listing price, you’ll move on to the next step. If it comes in lower, you’ll work with your agent to negotiate with the seller’s agent and decide if the property is still a worthwhile investment.
- Arrange a final walk-through. You fell in love with the home during your tour, but you’ll want to schedule a final walkthrough to ensure the home is move-in ready.
- Close on your second home. The last part of the process is paying closing costs, signing all of the closing paperwork and receiving your keys. Your agent, closing agent or attorney will manage this process to ensure all paperwork is in order.
