How to buy a second home

Step 1: Determine if you can afford a second home

Buying a second home means another mortgage payment, more property taxes and additional homeowners insurance.  Add up all the costs to ensure you can afford the expenses associated with applying for and taking on another mortgage. While some expenses may be similar for a first and second home, second homes can be costlier than you might think.

Property taxes are often higher on second homes than on primary residences, even in states that cap property taxes. For example, Indiana caps state property taxes at 1% of the property value for primary residences, 2% for second homes and farmland and 3% for other types of property.

Paul Sundin, CEO of Emparion, a retirement services provider, added that you may not be able to deduct property taxes on a second property on your tax return, although this depends on how much in property taxes you pay on your primary residence. As Sundin further points out, the Tax Cuts and Jobs Act of 2017 limited the total amount of property taxes you can deduct per year to $10,000.

This means that, if you're already paying $10,000 or more in property taxes on your primary residence, "you're no longer allowed to deduct any of it from your second home," he explained.

Interest rates on second mortgages are also often higher than those for primary home loans. This leads to even higher carrying costs on second homes.

Step 2: Make sure you qualify for financing a second home

The requirements for a second home mortgage are typically higher than for a primary residence. Lenders want to ensure you can afford the mortgage payment on your primary residence and any other properties you buy.

Generally speaking, you will need the following to qualify for a mortgage on a second property:

• A minimum down payment of 10% of the purchase price
• A minimum credit score of 620
• A DTI ratio below 50%, considering all debts, including the second home mortgage
• Two to six months of financial reserves in the bank

The requirements can be even more stringent if you want to purchase a second home to generate rental income. Specifically, you’ll typically need to come up with a down payment of 15% (and potentially more, depending on the lender).

However, you can likely use some of the future rental income to qualify for a mortgage on a home you plan to use as an investment property. In most cases, lenders let buyers use up to 75% of future rental income (e.g., $1,500 per month for a home that rents for $2,000 per month).

Step 3: Decide how you’ll finance a second home

Mortgage options for second homes are limited. You can only use government-backed loans like FHA and VA loans for a primary residence. That leaves you with conventional and jumbo loans to choose from.

For a conventional mortgage, you'll typically need a down payment of 10% to 15% of the second home’s purchase price. Also, you’ll have to pay private mortgage insurance (PMI) if you put down less than 20% of the purchase price.

If you’re using a jumbo loan, you’ll typically need to put down a minimum down payment of 20% to 25%, but sometimes 30% or more, depending on the lender. Fortunately, you can avoid paying private mortgage insurance (PMI) with any down payment of 20% or more, just like you can with a conventional mortgage.

To come up with a larger down payment for a second property, you can:

• Consider a cash-out refinance on your primary residence. Shelby McDaniels, channel director for corporate home lending at Chase, says a cash-out refinance on a primary home is often used to purchase a second home. This type of home loan lets you tap into your home equity and roll it into the new loan with a new interest rate and monthly payment.
• Take out a home equity loan or home equity line of credit (HELOC). A home equity loan or HELOC can also help you tap into your home equity to free up cash for the down payment on a second home. Home equity loans have fixed interest rates and fixed monthly payments. HELOCs typically have variable rates and base your monthly payment on how much you borrow.

Step 4: Buy a second home

Once you know you have what it takes to buy a second home, here’s how to turn your dream into a reality.

• Get preapproved for a mortgage. A preapproval letter for a second mortgage can strengthen your offer when you find a property you want to buy. You can typically get started by filling out a mortgage application online, but you may need to speak with a mortgage professional, depending on the mortgage lender you choose.
• Find a real estate agent you trust. Ask family and friends for recommendations for a real estate professional you can trust. Look for an agent who specializes in homes in your preferred area, whether you're seeking a vacation home in a tourist area or looking for a property you can easily rent out.
• Look for properties that fit your criteria. According to financial advisor Cecil Staton of Arch Financial Planning, location is one of the most important factors to keep in mind when searching for the perfect property. Will the home adequately suit your needs based on where it’s located? Staton also suggests researching the local market to ensure the property price is fair. A real estate agent with their finger on the market’s pulse can be a valuable asset here.
• Make an offer and close on the home. When you find the home you want, it’s time to make an offer. If the seller accepts your bid, the property will go through an inspection and appraisal; you'll need to negotiate with the seller on potential repairs and credits to lock in the deal formally.

Bottom line

You can buy a second home as a place to get away or to expand your real estate portfolio for investment purposes. No matter why you want a second property, you should know that you'll have to meet tighter mortgage requirements overall. These requirements can include a larger down payment, a higher credit score and greater financial reserves.

Staton, the financial advisor from Arch Financial Planning, pointed out that it's crucial to remember a second home is a significant investment, and you should treat it as such. Buying your second home is only part of the journey. From there, you'll need a plan to properly maintain and care for the home when you aren’t there.

"With careful planning and consideration, owning a second home can be a wonderful experience,” he said.