Hoping to buy a second home but need help with funding the purchase? Discover 5 different options for financing your second home.
Your primary home is one of the most expensive purchases you’ll ever make. A second home is a luxury that comes with significant costs of its own. And if you’re dreaming of a condo near your grandkids or an international vacation home for seasonal escapes, you’re probably wondering how people ever make those real estate fantasies a reality. That probably also leaves you wondering how to buy a second home with no down payment.
Traditionally, many people have relied on home equity financing to pay for a second property. However, there are other home equity loan alternative options out there, including cash-out refinancing and sale-leaseback programs.
If you’re ready to make the jump and add a vacation property to your portfolio, you’ve come to the right place. We’ve put together this guide to everything you need to know to make the best decision for your financial and real estate future.
Costs to Consider for a Second Home
The price of the investment property isn’t the only thing to consider when you explore how to afford a second home. Financing, upkeep, and maintenance costs can all put a big dent in your monthly budget.
You’ll need a financial plan that accounts for all the following costs.
Financing a second home is quite expensive and, if you’re not careful, it can easily put you in a position where you’re paying far more than you’re comfortable with. Remember, a second home comes with the following costs:
- Down payment – You’ll need to have access to enough funds for a downpayment on your investment property. Depending on your financing and other factors, this can be anywhere from 3% to 20% or more of your offer price.
- Secured Loan fees – Secured loan origination fees, title costs, private mortgage insurance, closing costs, and more are all part of purchasing a home. These charges can add up to a significant chunk of money when purchasing a vacation property. Most banks will require proof of funds to cover these second home loan costs.
- Monthly payments – You’re taking on a new obligation to make monthly payments on your second home mortgage. That’s all on top of your primary home mortgage.
Upkeep and Maintenance Costs
Along with paying for the financing on your second home, you’re also responsible for the upkeep and maintenance costs, including:
- Utility bills – Paying two electric, water, and gas bills can get quite expensive. Make sure you’re prepared to handle these additional monthly costs.
- Repairs – Even if you rent out your second home, you’re still responsible for needed repairs on the rental property. Fixing major problems can take a hefty chunk out of your expected income from the rental property.
- Maintenance – You also have to consider general maintenance such as lawn care, snow removal, and cleaning for your second property.
- Property taxes – Finally, you’re responsible for two sets of property taxes when you own two homes.
These are all important factors to consider before investing in a second home. Can you afford the financing and upkeep of two properties?
5 Financing Options for Buying a Second Home
You need to know how to finance a second home if one is indeed in your future. There are several options for obtaining the money if you don’t have the cash on hand to afford a down payment or closing costs.
To qualify for mortgage financing on a second home, you need to meet the debt-to-income requirements of your lenders. Typically, you cannot exceed 43% of your total income in monthly debt payments.
This means the total mortgage payments on both of your homes added to any other debt you pay monthly must be less than 43% of your total monthly income. If adding a second home to your portfolio would send your monthly obligations higher than this, you may not qualify for a new second home mortgage.
Beyond the mortgage, you may need cash to cover the down payment, closing costs, and other expenses. While some financing solutions involve adding to your overall debt, others leverage your home equity or other assets to pay for your new home.
Possible ways to fund your purchase include:
1. Home Equity Financing
If you have significant equity in your current home, you might be able to obtain financing through one of the following methods:
- Home equity loan – A home equity loan allows you to access the equity you have in your home through a loan (also called a “second mortgage”). You receive the cash as a lump sum and make monthly payments until the 2nd mortgage is paid off.
- Home equity line of credit (HELOC) – A HELOC functions more like a credit card. Instead of a lump-sum payment, you receive a line of credit based on the amount of equity you have in your home. You use only what you need and make payments based on what you’ve used. You can use this credit to finance a new home.
Both of these options result in additional monthly payments for the borrower. In addition, both use your home as collateral. If you’re unable to keep up with payments, you could lose your home to foreclosure. If you need help deciding between the two, check out our comparison of a home equity loan vs. HELOC.
2. Cash-Out Refinancing
Cash-out refinance loans allow you to take out a new loan for more than your original mortgage amount. That loan pays off the original mortgage, and you receive the remaining balance in cash to use as needed.
This might sound like an ideal solution because it allows you to consolidate debt and access needed cash, but it also comes with drawbacks and risks, including:
- The costs of originating a new loan with new terms
- Less favorable terms (for example, a higher interest rate)
- A longer payback period
3. Reverse Mortgage
A reverse mortgage is an option that’s only available to borrowers age 62 and older. This type of mortgage refinance allows you to borrow against the equity you have in your home. You’ll receive payments, and the balance on the loan will be due only when you sell the home or pass away.
Along with the age limitation, there are several criteria that you must meet to qualify for a reverse mortgage:
- If your spouse isn’t at least 62 years old, they cannot be on the title with you.
- You must have significant equity in your home (usually 50% or more).
- The home must be your primary residence.
- You must complete a consumer counseling course.
A reverse mortgage has some advantages but comes with pretty strict qualifying criteria. As with other loan options, keep in mind that you could lose your home if the loan terms aren’t met. If this financing option doesn’t work for you, there are other alternatives to reverse mortgages.
4. 401(k) Loan
You may be able to take out a loan from your retirement account to finance your second home purchase. However, there are serious consequences and limitations to this option. These include:
- Limitations – You can borrow up to 50% of the money you have invested in your 401(k) account up to $50,000. Even if you have significantly more money in your account, $50,000 is the limit you can take out.
- Interest rates – Even though withdrawing money is essentially borrowing from yourself, you still must pay interest on the loan. The interest you pay does end up going back into your 401(k) account, but it’s additional money you must come up with out of your pocket to make your payments. Furthermore, your account will accrue less interest with less money in it.
- Taxes – Taxes are a major concern if you borrow from your 401(k). You have to pay taxes on the interest you pay yourself. You’ll once again pay taxes when you withdraw from the account during retirement.
- Fees – Although they’re fairly minor, fees are still a consideration with a 401(k) loan. You might have to pay a fee somewhere between $50 to $150. If you fail to pay the loan back within 5 years, the IRS may also charge you an early withdrawal fee of 10%.
While it may be tempting to tap into your retirement savings, this option comes with a lot of downsides. If you’re deciding between options, learn the difference between using a home equity vs. 401k loan.
5. Alternative Funding Options
If none of the aforementioned financing choices appeal to you, don’t despair. There are other funding options out there, and they may be better suited for your long-term financial goals.
An individual with significant equity in their home can explore a sale-leaseback option. This allows you to sell your home, easily converting the equity to cash while remaining in your home as a tenant. You’ll have the time and money you need to reach your financial goals without the hassle of some of the traditional home financing measures.
If you’re wondering how to finance a second home, there’s a lot to consider. The home’s price is just a portion of the costs you might incur. Financing costs, home upkeep, and the second set of property taxes are all part of the deal. If you want to convert home equity to cash without taking on debt, explore sale-leaseback programs.
Hoping to buy a second home but need help with funding the purchase? Discover 5 different options for financing your second home. If you are still unsure of alternative options to financing your new home after reading this article, consult a financial advisor to discuss your options.
- Consumer Financial Protection Bureau. What is a debt-to-income Ratio? https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-to-income-ratio-why-is-the-43-debt-to-income-ratio-important-en-1791/
- Debt.org. Understanding Home Equity. https://www.debt.org/real-estate/understanding-home-equity/
- Debt.org. Mortgage Cash-Out Re-Fi. https://www.debt.org/real-estate/mortgages/refinance/cash-out/
- Debt.org. The Reverse Mortgage: Pros and Cons. https://www.debt.org/real-estate/mortgages/reverse/