6 ways to fund a second home down payment

Buying a second home is a goal for many people. Whether you decide to use it as a vacation home, a quiet work retreat, or an income-generating rental property, it takes significant planning and effort to come up with a second home down payment.

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Many lenders require a large down payment for second homes. If you don't want to spend months saving up for one, there are several ways to finance a down payment for a second home. This article will share several examples as well as their benefits and drawbacks.

What’s the average down payment for second home purchases?

Many lenders require a higher down payment for second homes than borrowers would pay for a primary home. You can expect to pay at least 10% to 20% of your second home's purchase price as a down payment.

6 ways to fund a second home down payment 

If you want to borrow money to use as a down payment for your second home, here are a few options to consider.

Bridge loan

How it works

A bridge loan is a short-term loan that you can use to fund the purchase of your new home. It's designed to help borrowers leverage their current home's value to pay for their next home while they wait for their current home to sell.

Requirements

Most lenders require borrowers to have a solid amount of equity in their homes and good credit to qualify for a bridge loan.

Special considerations

Bridge loans are typically best for people who plan to sell their primary residence and buy another. If you want to keep both homes, a bridge loan might not be the best choice for you. Additionally, bridge loans can sometimes come with higher interest rates than other financing options.

DSCR loan

How it works

DSCR stands for Debt Service Coverage Ratio. These loans are typically for investment properties. If you want to buy a second home with the plan to turn it into an income-generating asset, you can apply for a DSCR loan. 

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This type of loan enables you to borrow money based on the income the property generates rather than basing the loan on your credit history and profile.

Requirements

There are specific requirements needed to qualify for a DSCR loan. Typically, the property must have a rental income exceeding the monthly mortgage payment.

Special considerations

A DSCR loan is a particular type of loan for investors who don’t want a conventional loan or a government backed loan. However, because the real estate market tends to fluctuate, the requirements for property income can sometimes be challenging to meet. 

Home equity loan/HELOC

How it works

A home equity loan or a home equity line of credit (HELOC) allows you to leverage the equity you already have in your home and borrow against it. With a home equity loan, you get a lump sum and pay back the loan in equal monthly installments over time.

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A home equity line of credit (HELOC) works similarly to a credit card where you are approved to borrow money up to a certain amount and can take funds out as needed. You can pay down your balance to create more space to borrow more. 

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HELOC repayment plans are flexible because you can make interest only payments for a period of time before you have to pay down your principal.

Requirements

Most lenders require borrowers to have a good credit score in order to qualify for a home equity loan or a home equity line of credit. Lenders will review your debt to income ratio, your income, and the equity you have in your home.

Special considerations

The biggest drawback to getting a home equity loan or home equity line of credit is that if you don't make your payments on time, your lender can foreclose on your home. Because your home is the collateral for the loan, only take out this type of loan if you are confident you will be able to make your monthly payments on time.

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Home equity investment

How it works

With a home equity investment, you get cash in exchange for a share of your home’s future value. It’s a form of equity financing for homeowners. The company makes money when you buy back your equity from them or when you sell your home in the future.

Requirements

In order to partner with a home equity investment company, you must have existing equity in your home. However, you don’t have to have an income or a perfect credit score.

Special considerations

The benefit of a home equity investment is that you get cash up front, and you don't have to make monthly payments. However, you also won’t know your exact repayment cost until it’s time to settle up. 

Cash-out refinance

How it works

A cash-out refinance is another way to tap into the equity of your current home for financing a second home. With this process, you get a new home mortgage to replace your current mortgage, and a new monthly mortgage payment. 

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Because your home value likely increased over time, you can borrow more than you currently owe on your mortgage and take out the difference in cash.

Requirements

Most lenders require you to have at least 20% equity in your home after you complete the cash out refinance. So, this is best for people who already have significant equity in their home.

Special considerations

If you have a low interest rate on your mortgage, getting a cash out refinance might not be in your best interest. Because mortgage rates have gone up considerably over the past few years, it might be very expensive to refinance to a higher interest rate. Additionally, you’ll have to pay closing costs and other fees when you refinance.

401(k) Loan

How it works

A 401(k) loan is when you essentially take a loan from yourself via your retirement account. If you have a 401(k), and your employer allows 401(k) loans, you can borrow against your current savings. After you borrow the money, you can repay the loan back into your retirement account.

Requirements

Only some 401k accounts allow customers to borrow. If your plan allows 401(k) loans, you can only borrow a specific amount or percentage, as outlined by the IRS.

Special considerations

Many people take out 401(k) loans because the money is already theirs and doesn't require a credit check. Of course, the drawback is that you're borrowing from your future self. If you take out money from your 401(k) that's money that is not invested in the market. Additionally, if you don't repay your loan on time, it will count as an early withdrawal, which comes with penalties. 

Is it better to save or finance a down payment?

Deciding whether or not to save cash for a second home down payment is a personal choice. 

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Saving cash for a down payment ahead of time can help you avoid debt and extra interest payments. However, many people prefer to keep their cash on hand. Additionally, saving takes time, and if you want to jump on a specific real estate opportunity, financing might make more sense for you.

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Again, deciding whether or not to finance your down payment on your second home is completely up to you and your personal risk tolerance. 

Final thoughts

You can save cash over time for your down payment or use one of the financing options mentioned above to get your down payment for a second home.

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Each option mentioned above has pros and cons and requires thoughtful planning. Hopefully, by finding one that works for you, you will be well on your way to enjoying your second home very soon.

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