You’ve worked hard for your home, but life doesn’t always keep us tied down in one place. Maybe it’s time to purchase an investment property, spend more time with your grandchildren across the country, or simply enjoy a more comfortable climate during certain times of the year.
There are many reasons why you might consider buying a second home, and spending some time planning in advance can smooth out your home-buying journey. We’ll help you figure out if you’re ready and go over a few popular options for how to buy a second home.
Assessing your financial situation
Planning out your budget is one of the biggest things you can do to make sure you’re able to enjoy your second home to the fullest, without any stress or worries about money. It’s a good idea to consult a financial advisor who can give you the best guidance and advice, but you can also check your financial situation out for yourself.
How to know if you can afford a second home
The first step in buying a second home is making sure you can comfortably afford it. You can get a good idea of this by starting with your current budget.
To start, make a list of all your current monthly income and expenses. For bills and expenses that you pay on a semi-annual or annual basis, you can split them up into monthly chunks so you can get a better idea of your overall costs. Remember to include estimates for all of your spending, including things like travel, hobbies, clothing, holiday gifts, and savings goals.
When you’re done, compare your expenses to your income. How much do you have left over each month? That’s what you can potentially afford to pay for a second home. You can also increase the money in your budget for a second home by doing things like cutting your expenses, considering a lower-cost home such as a condo, or finding new ways to grow your income. If you’ll be purchasing a second property as an investment, make sure to include your potential revenue and expenses in your budget as well.
Setting a realistic budget for a second home purchase
Once you know how much extra money you have in your budget, you can figure out what type of home you might be able to purchase. One way to figure this out is by using a mortgage calculator to get an idea of what your monthly mortgage payment might be based on different factors such as your down payment, the price of the home, your interest rate, and more.
Remember to include other homeownership costs in your potential budget. For example, you’ll need to pay for utilities like internet and phone service at your new home and save up for routine maintenance and repairs. Consider any travel costs between your current home and your second home, as well as any hired help such as house-sitters or rental managers. You may also want to furnish your home, or budget for any new hobbies like sailing or golfing.
It’s also a good idea to leave some wiggle room in your budget. You don’t have to spend every last cent available in your current budget on a new home. Leaving yourself some extra wiggle room can help you avoid straining your finances because you’ll be better equipped to handle any financial surprises or changes that pop up in the future.
Qualifying for a second home
Many lenders have stricter requirements for buying a second home compared to when you bought your first home. It’s a bit riskier for your lender, after all, and so they’ll do a thorough job of making sure you can afford it.
One of the most important factors is your debt-to-income ratio, or DTI ratio for short. This is simply a measure of your monthly debt payments divided by your monthly income. In other words, it’s how much of your monthly income goes towards debt, including any mortgages. Most lenders require a DTI ratio of 43% or less. As your DTI ratio gets closer to 43%, the more difficult it will be to get approved for a mortgage on a second home.
Another major factor is your credit score. Each lender is different, but you’ll generally need a good credit score of 650 or higher in order to qualify for a mortgage on a second home. There may be exceptions, however, which we’ll cover later on. It’s a good idea to check your credit report and look for any errors before you apply for a home mortgage. This gives you an opportunity to dispute and fix any errors, which are unfortunately common.
Most — but not all — lenders also require a larger down payment of at least 10% to 20% when you’re purchasing a second home. It’s a good idea to put at least 20% down for a mortgage if you can anyway, for a few reasons. If you’re using a conventional mortgage, making a minimum down payment of 20% can help you avoid extra private mortgage insurance (PMI) fees. It’ll also help you start off with plenty of home equity that you can use to build more wealth or borrow against if you need to make a large purchase.
The pros and cons of buying a second home
Purchasing a second home is a big decision. To get the most out of your decision, it’s a good idea to consider all of the benefits and drawbacks:
- Potential to have more tax breaks
- May add extra income if it’s an investment property
- Can help you build more equity and wealth
- Allows you to keep in touch more with the people and places you love
- Can help you leave more of a legacy for your loved ones
- May pay higher interest rates
- Can require a larger down payment
- Can be tougher to qualify for a second-home mortgage
- Requires careful planning to avoid straining your budget
- May have to agree to extra mortgage requirements
- Extra support and maintenance to manage
5 Ways to buy a second home with no down payment
Most financial experts recommend making as large of a down payment as possible. A larger down payment means you won’t need to borrow as much money, making your monthly mortgage may be a lot more affordable — especially if you’re buying a second home. However, you’re not alone if saving up a larger down payment is a tough challenge. Here are a few strategies for how to buy a second home with no down payment:
Government-backed loan programs
Two particular government-backed mortgages — VA loans and USDA loans — do allow you to purchase a second home with no money down, although there are limits. USDA loans, for example, are limited to people who earn below 115% of the median income in the rural area where they want to purchase a home. VA loans are limited to military service members and veterans.
One important thing to note is that these two programs can only be used to purchase a second home if it’ll be your “primary residence,” meaning you can’t use it for a vacation home. You can, however, use it to purchase a second home to live in full-time, while keeping your first home as a vacation home or rental.
Explore seller financing options
Most people apply for a mortgage from a traditional lender in order to purchase a second home, but that’s not always the case. The person selling the home may be able to finance the purchase themselves, if they have the financial ability and desire to help you purchase their home.
These situations are more rare, but they are possible to find with your realtor’s help or by browsing real estate websites. If the seller is open to a seller financing arrangement, it’s a good idea to work with a lawyer experienced in drawing up these types of contracts who can help guide you.
Leverage home equity
You already have a large resource available to you: the equity you’ve built up in your current home. Many people opt to use their home equity to help them afford a down payment on a second home.
To qualify, you’ll often need at least 20% equity in your current home, depending on the lender. This can be a cheaper option if your credit needs some work, since bad credit home equity loans may be easier to get and more affordable than alternatives.
An easier route for many second-home buyers is simply taking the reigns over on the home seller’s current mortgage. This is more commonly allowed with government-backed loans like VA, USDA, and FHA loans, if you’re able to meet the loan requirements on your own as well.
For example, if you’re a veteran and the person you’re trying to purchase a home from is paying off a VA loan for the home, you may simply be able to transfer the loan into your name instead. You’d then continue paying it down right where the old owner left off.
Leasing with an option to buy
These contracts are offered by some home owners, and are also known as a “rent-to-own” arrangement. In a rent-to-own arrangement, you agree to pay rent and abide by the other terms of the contract for a set period of time, after which you get the option to purchase the home.
Each contract is different so you’ll need to check it over with a fine-tooth comb and consider all the potential pros and cons. Many contracts have a provision to set aside a portion of your monthly rent payment towards an eventual down payment.
It can be difficult to figure out how to buy a second home, and it’s not right for everyone. But if you’ve checked whether you can afford it, buying a second home can greatly enhance your lifestyle.
There are many paths to purchasing a second home, and for many people, using your existing home equity is an excellent option. Make sure to fully explore your choices, including home equity investments (HEIs) from companies like Point, which can offer you upfront funds now in exchange for a portion of your current home’s future appreciation.