If you’ve found the vacation spot that’s right for you, you may want to trade in hotel rooms and Airbnb rentals for a second home. Second homes make up approximately 5.11% of the total housing stock. That’s just over 7.15 million properties in 2020.
Sounds like a lot of people are living the American Dream and then some. But before you start comparing lenders, you’ll want to find out about second home mortgages. They aren’t aren't as straightforward as securing financing for your primary home.
What is a second home mortgage?
Second-property mortgages are loans used to finance a second or vacation home.
Strictly speaking, these mortgages are identical to any other type of mortgage, but in the eyes of lenders, they have different risk profiles. As a result, most people looking to buy a vacation or second home have to comply with a different set of requirements.
Second Home Mortgage Requirements
Before we can discuss how to get a second home mortgage, we have to mention that many lenders have stricter standards for determining if a property even qualifies. Lenders often requires that:
The home must be a single-unit dwelling.
The property must be suitable for occupancy 365 days per year.
You have exclusive use of the property (i.e. ,these mortgages aren’t used for timeshares or long-term leases).
A property management company must not control the home.
The home must be located a minimum distance from your home. (Lender requirements often vary on this point.)
If you secure a second mortgage, you may still have the option to rent out the property when you’re not using it. However, most lenders that allow rentals restrict the total rental time to 180 days yearly. Furthermore, this potential rental income cannot be factored into your calculations for mortgage qualification purposes.
Note: If you intend to consistently rent out your vacation home for long stretches, then you may need an investment property mortgage. This is a different financial plan that often has stricter rules.
Assuming your dream property does qualify under second home mortgage rules, what should your financial portfolio look like before applying?
Like all types of financing, lenders are free to set whatever requirements they like. That said, practically all lenders opt for the same minimum standards, including:
At least a 20% deposit.
A debt-to-income ratio of 43% or less, but some lenders may stretch to 50%.
A credit score of at least 620.
Proof of cash reserves to cover several months of mortgage payments.
Why are second home loan requirements so strict?
One reason for the strict second home loan requirements is the perception of risk. Your primary residence is a necessity, but a second home is usually considered a luxury. Homeowners are more likely to fight to keep their primary homes when the going gets tough.
There are things you can do if you’re struggling to meet these requirements. One option is to accept a higher interest rate or provide a larger deposit. But in most cases, the answer is to compare and apply to multiple lenders.
Qualifying for a second mortgage: Step by step
The lenders who offer second property mortgages will likely require you to prove that you can handle the repayments comfortably and may look upon buying a second home mortgage with a keener eye than other types of mortgages.
In this section, we’ll discuss how to get a second mortgage to buy another house by focusing on each requirement and how to meet it.
One of the most specific requirements to meet is cash reserves, also called mortgage reserves. The more cash reserves you have, the higher your chance of qualifying. Lenders typically ask for evidence that you have enough in your savings account to cover two to six months of mortgage repayments as part of your application.
That’s trickier than it looks because the median bank account balance is $5,300. This means most Americans wouldn’t qualify without actively increasing their savings rates.
Of course, your savings and checking accounts aren’t the only cash reserves a mortgage company might look for. Others include:
Certificates of deposits.
An insurance policy’s cash value.
Stocks, bonds, and mutual funds.
Funds in a trust.
Vested retirement funds.
You can find tips for building up your cash reserves in our article 13 ways to afford a house.
Second home deposit
Primary homes require a 10-15% deposit to secure a mortgage, but you can expect to put down at least 20% to as much as 25% on a second home. In popular vacation spots, your deposit could easily exceed $100,000 because of this requirement.
Remember, you can’t use potential rental income as a substitute for a deposit, so you need to have the money available immediately. Some lenders may allow you to use proof that you’re selling an existing second home to finance the deposit of the next one.
Your credit score must be good to excellent to qualify for one of these mortgages. One of the aspects of the application process that surprises people is how much stricter lenders are on credit scores. Some lenders may consider a credit score of 600 acceptable, but you’re more likely to need a score between 620-650 to qualify.
Like with any other mortgage, higher credit scores yield better mortgage rates. If you have minimal debt and time to spare, working on your credit score before you apply can pay dividends.
Your debt-to-income ratio is the amount of your gross monthly income used to service your existing debt. All forms of debt are factored into this calculation, including:
Most lenders want you to have a debt-to-income ratio of 43% or less, but some lenders may stretch to 50% if you have an excellent credit score.
The only way to improve this is to pay your debts or increase your income. For most second-home hunters, the best option is the former.
Finally, the lending market is a highly competitive one. Even among second mortgages, lenders are fiercely competing for your business.
Be willing to approach multiple lenders to get the best deal. However, if you’re experiencing a relatively high rejection rate, it could indicate a fundamental weakness in your current financial situation. Ask yourself:
Is my credit score high enough?
Am I trying to purchase a property outside of your current income level?
Do I hold too much personal debt?
Chances are that the answers to these questions will give you an idea of what you have to do to improve your luck with mortgage companies.
What if my mortgage application was rejected?
If you believe you have met all of the qualification requirements for your second mortgage and weren’t approved, you may wonder how you’ll ever get a second home mortgage.
If you barely qualify for a second home mortgage in one or more areas, then you have two choices: apply to a different lender or work on strengthening your application.
But if you’re at a loss as to why you were rejected, you may want to:
Ask the lender. Lenders are supposed to explain why they rejected your application. Remember, the requirements they set down are only a guideline. They’re free to alter their conditions and reject applicants for any reason.
Take a look at your credit. Get a copy of your credit report and analyze it. Is there a mistake in the report? Has something changed that could have altered the lender’s view of your application?
Deal with student debt. Student debts can have an outsized impact on your debt-to-income ratio. One way to combat this issue is to opt for an income-based repayment plan, which could reduce your monthly repayments and debt-to-income ratio.
Finally, sometimes the answer is to visit a different lender. Countless lenders offer second mortgages, so you may have more luck by applying for a mortgage elsewhere. Don’t give up on your dream of owning a vacation home just because one lender turned you down. Rejections are extremely common within the second mortgage market.
Down payments options for a second home
Making the down payment on your second home is often the trickiest part of the process. While most people believe that cash only is your sole option, this isn’t true. Lenders permit several options for putting together the down payment on your dream home. Let’s examine some of the solutions to meet that requirement.
Tap your savings
If you’re unwilling to take on further debt or give up any equity in your primary home, you may want to consider using your savings to finance the down payment.
Although most Americans rely on mortgages to purchase a vacation home, many will use the cash they have saved over the years to cover the down payment. But is using your existing savings right for you? Ask yourself these questions:
Will using my savings compromise my emergency fund?
Can I stand the loss of liquidity?
Have I built up enough equity to avoid using my savings?
Ultimately, the answer is unique to everybody. To find yours, look over your savings and any plans that could require you to have liquid cash available over the next few years.
Opt for cash-out refinancing
Cash-out refinancing enables you to use the equity you’ve built up in your primary home. The number of cash-out refinancing applications has increased since the COVID-19 pandemic. In 2021, homeowners took out $275 billion in equity, the highest figure since 2005. While the reasons for this vary, utilizing your equity may enable you to leave your savings untouched.
So what makes cash-out refinancing a good idea? Here are a few indicators:
Lower interest rates. Cash-out refinancing can provide a lower rate on an existing mortgage on your primary residence, enabling you to pay for your second home while lowering your current rate.
High equity. If you have already built up a significant amount of equity in your home, cash-out refinancing may be ideal
Good credit. As with other financial products, cash-out refinancing with a good credit score can enable you to borrow up to 80% of your home’s current value.
Cash-out refinancing is one of the best ways to use your home’s equity, but you should always double-check the terms of the product. Like with a conventional mortgage, cash-out refinancing still brings the risk of foreclosure if your financial situation changes.
Take out a HELOC
The Home Equity Line of Credit (HELOC) is another popular option to pay for your secondary home. A HELOC allows you to borrow against your home’s equity, with your primary home as the collateral. You can use that equity to cover the down payment on your second home without refinancing your current mortgage.
Nearly one in five Americans use HELOCs, so how do you know if this financing option suits you?
Are you comfortable using your home as collateral?
HELOCs are secured against your home’s current value minus anything you owe on your existing mortgage. If you cannot repay the loan, your home could enter foreclosure. That means you may lose both your primary and secondary homes.
As a form of secured loan, you must be comfortable using your primary residence as collateral. For many older Americans, risking the home they spent decades paying off may be too risky a step.
Can you handle changing interest rates?
HELOCs and credit cards share variable interest rates. Changing economic conditions could lead to larger monthly repayments on your HELOC.
Interest rates have increased quite a bit lately. For example, in March 2022, Federal interest rates were nearly 0%, but in March 2023, the Federal rate increased from 0% to 4.75-5%, which impacts every financial product in the country. You have to decide if your finances would be able to cope with rate hikes like this.
Protect your second home with insurance from Kin
Just like your primary residence, your second home is an asset that carries substantial value, so it makes sense to protect it. That’s where we come in.
Our second home insurance helps safeguard this investment without breaking your budget. By offering coverage directly to you, we’re able to save our members hundreds of dollars.
Ready to learn more about our customizable plans? Give us a call at 855-717-0022, or enter your address to get a quote now.