There are different categories for real estate that lenders recognize. The most common is a primary residence. This is a home where the owners live full time. The best financing terms are reserved for a primary residence. Lower down payments and more competitive interest rates are afforded homes that are classified as a primary residence.
Real estate can also be an investment property. An investment property, as the name implies, is purchased for monthly cash flow as well as equity appreciation over time. Investor loans will have slightly higher interest rates compared to a primary residence and can also ask for more down payment.
For instance, investment or rental properties might have an interest rate up to 0.50 percent higher compared to a primary residence. Such a property can also require a down payment of 20 to 25 percent of the sales price. More down payment and higher rates are used to offset the additional risk of financing a rental. The thinking is that should someone that owns an investment property as well as a primary residence, should that person ever get into some sort of financial distress, making the mortgage payments on the primary residence takes priority over a rental.
But there is a third category reserved for a vacation or a second home and the terms for such properties are more favorable compared to a rental. Even if the property is rented out at some point over the course of a calendar year. Rates and terms for a vacation home are “in between” financing for a primary residence and a rental property. How does a lender know whether a home is a vacation home or an investment property?
Initially, the status of a vacation home must make sense. A vacation home can be located in the mountains away from suburbia or on a beach near the ocean. A vacation home isn’t typically located across town and rented out.
The most competitive terms can come from a home equity line of credit, or HELOC, taken out on a primary residence or a home equity loan in the form of a second mortgage. Financing for a vacation home can mean a down payment of as little as 5 percent in some cases, with favorable terms like conventional loans. However, remember that a conventional loan where the balance is more than 80 percent of the property value, private mortgage insurance, or PMI, will be likely be required.
Tip: Government loans like FHA, VA, USDA are only permitted for primary homes, second homes are not eligible. Only conventional and Jumbo loans are available for second homes, in some cases up to 95% financing.
Buyers will also need to qualify based upon the new mortgage for the property, including taxes and insurance. This means being able to carry your current mortgage and the new one based upon your current income. Even if the property is rented out during some period of the year, it’s not likely that income can be used to help qualify. It may be possible to use rental income if the property is categorized as a rental and you currently own other rental property. Otherwise, be prepared to qualify with both mortgages.
Even though you may not be able to use any rental income to help qualify, having additional income generated from the home is an appealing perk for owners. Many times, buying a vacation home comes along quite by accident. Someone rents a vacation home up in the mountains for a two-week stay and suddenly that person starts thinking about owning that home instead of renting it. And if the home is rented out, what type of income might be generated?
This information can all be obtained by contacting a local real estate agent, typically the one you spoke with who helped arrange your stay. This person can likely act as your property manager as well. The property manager takes care of any maintenance issues throughout the year, markets the property, qualifies and screens tenants and collects rent when due. You can also get a rental history of the unit showing how much was collected over the past year. Managing a non-owner occupied property is something that really can’t be done long-distance, so a property manager is a must.
Feel free to speak to one of our specialist about current interest rates for a vacation home and work up some monthly payment information. If the rental income partially or completely offsets the mortgage payment including property taxes and insurance, it might make some very good sense to buy instead of rent. How long you decide to rent out the property is up to you but to get the most favorable financing, stay within lending guidelines for a vacation or second home.
For more info please call us at 800-871-2636 or just submit the Request Contact form at the top of this page.