What to know about second home mortgages
A second home can be an excellent investment. Not only does it give you a place to vacation and help you avoid pricey rentals, but it can also generate cash flow.
If you rent your vacation home out and use the income to pay its mortgage, your vacation home could potentially pay for itself.
Before you jump in, though, you should understand the rules and requirements for a second home mortgage. They’re a little different from the mortgage on your main home. Here’s what you need to know.
In this article (Skip to…)
- How to buy a second home
- About second home loans
- Mortgage rates
- Home equity loans
- FHA and VA loans
- Rental vs. vacation home
- Mortgage options
Two ways to finance a vacation home
There are two main ways to finance a second home or vacation property:
- Using your existing equity: You could cover all or part of the purchase using the equity in your primary home. This is possible via a cash-out refinance, home equity loan, or home equity line of credit (HELOC) on your current home
- Using a conventional loan: You could finance the purchase by taking out a conventional loan on the second home itself. This process would be much like taking out a loan on your primary home, but with slightly tougher requirements
You could also combine these two loan options. For example, you could borrow from your home equity to generate the down payment while using a conventional second loan to cover the remaining balance.
For this to work, you’d need enough income to qualify for both loans simultaneously. Your monthly budget would need enough room for both loan payments.
About second home mortgages
It’s common to get a mortgage for a second home. Over half of all second home buyers use a mortgage rather than paying cash.
But financing a second home or vacation home comes with different rules than financing a primary residence. Before applying for a vacation home loan, you should know that:
- You’ll likely need at least two months of cash reserves
- You’ll need to put at least 10% down
- Credit score requirements are higher than for a primary residence
- Interest rates are slightly higher than for a primary residence
- You could potentially use rental income to help cover your mortgage payments
Perhaps most importantly, you must live in your vacation home for at least part of the year. Otherwise, it counts as an investment property — not a second home — and you’ll have to meet different mortgage requirements.
Second home mortgage requirements
Second home mortgage requirements are a bit stricter than first home loans.
Fannie Mae and Freddie Mac — the two agencies that set conforming loan guidelines — have requirements for both the borrower and the home being purchased.
Second home mortgage borrower requirements
The most important requirement is that you need at least a 10% down payment. This rule is non-negotiable.
Beyond the down payment rule, guidelines for second home mortgages can be flexible. Borrowers may be approved with:
- A credit score of 680 or higher (typical)
- A credit score of 640-679 (with a down payment of 25% or more)
- A debt-to-income ratio (DTI) up to 45%
If one area of your application is weaker, you can often compensate by being strong in other areas.
For example, if your credit score is right at 640, you may get approved by making a bigger down payment. Or, if you have a high debt-to-income ratio, you could make up for it with an excellent credit score and 12 months of cash reserves in the bank.
Thanks to this flexibility, it’s possible to qualify for a second home mortgage even without perfect credit or a big down payment.
Second home mortgage property requirements
In addition, the property itself needs to meet certain guidelines. It must be:
- Occupied by the owner for some portion of the year
- A one-unit home (not a duplex, triplex, or four-plex)
- Suitable for year-round use
- Owned solely by the buyer
- Not rented full-time or operated under a timeshare arrangement
- Not operated by a property management company that has control over occupancy
That first rule, which states you must occupy the home part time, is the most important.
Why do vacation home loans have residency requirements?
You couldn’t finance a property using a second home mortgage and then rent it out full time. You yourself need to stay there for part of the year.
Why? Because if you plan to rent the home full time, it’s considered an investment property — not a second home. Investment property loans have higher interest rates and different loan requirements.
In addition, the home must be a reasonable distance away from the buyer’s primary residence. It also helps if the house is in a resort community or area.
In short, the property must “feel” like a recreational residence, not a rental property posing as one.
Down payment for a second home
You can buy your primary residence with just 3% down in many cases. But it takes at least 10% down to buy a vacation home — and that’s if the rest of your application is very strong (high credit score, low debts, and so on).
If you have a lower credit score or higher debt-to-income ratio, your mortgage lender may require at least 20% down for a second home. A down payment of 25% or higher can make it easier to qualify for a conventional loan.
If you don’t have a lot of cash on hand, you may be able to borrow your down payment.
Assets needed for a vacation home purchase
When you buy a vacation property, you’ll probably need some cash in reserves. Reserves are funds you could use to pay your mortgage if you experienced a short-term interruption in income.
One month of reserves is equal to the amount of money it would take to make one monthly payment on both your primary residence and future second home.
You’ll need at least two months of reserves if you’re a well-qualified wage earner, and at least six months of reserves if you’re self-employed or have any weak points in your finances.
If you have at least 12 months of cash reserves, you may be able to get away with a slightly lower credit score or higher debt-to-income ratio on your second home mortgage application.
Credit score needed to buy a second home
Credit score requirements are slightly higher for second homes than for primary residences.
Fannie Mae sets its minimum FICO at 620 for primary home purchase loans. But a second home loan backed by Fannie Mae requires a minimum credit score of 640 — and that’s with a 25% down payment and DTI below 36%.
If you make a down payment of less than 25%, you typically need a credit score of at least 680 and low debts, or 720 with a higher debt-to-income ratio.
Credit score requirements can also vary by lender. If you’re having trouble qualifying for a vacation home loan when you first apply, try shopping around for a lender with more lenient requirements.
Income required for a second home
Debt-to-income ratio requirements depend on the size of your down payment and your credit score. Fannie Mae allows a DTI up to 45% with a 660 FICO and at least 25% down.
A 45% DTI means your total monthly payments add up to 45% of your gross monthly income.
For example, if you make $10,000 per month before taxes, your total monthly debt payments could reach up to $4,500. That includes your primary mortgage payments, second mortgage payments, auto loans, and other ongoing debts.
Unlike investment properties, you cannot use future rental income to help you qualify for a vacation home. You have to qualify with income from sources other than the property you are purchasing.
If you’re buying a multi-unit vacation home, lenders will almost always treat your purchase as an investment property, whether or not you plan to rent it out.
Second home mortgage rates
Second home loans have only slightly higher interest rates than first home mortgage loans.
As with your main home, it pays to shop aggressively for your best mortgage rate.
Compare offers from at least three to five different mortgage lenders, and remember to look at their fees and annual percentage rates (APR) as well as the quoted mortgage rates.
To make sure you qualify in the first place, take a look at your assets, credit, and income — like an underwriter will.
You’ll have the best chance at a low second home mortgage rate if you pay down outstanding debts and get your credit score as high as possible ahead of time. A bigger down payment of 25% or more can help you get a lower rate, too.
Using home equity for a vacation home down payment
The National Association of REALTORS® says about a fifth of vacation home buyers tap into equity from their primary residence to make the down payment on the second home.
When rates are low, a cash-out refinance could have the double benefit of covering your second home down payment and lowering the interest rate on your primary home loan.
What about using FHA loans or VA loans?
The U.S. government doesn’t sponsor loans for vacation homes since government-backed loans are meant to encourage primary homeownership.
However, if your seller already has a government-backed loan against the property, you may be able to assume the seller’s loan.
It’s also possible for veterans who qualify for VA loans to buy a new primary residence with a VA loan while converting an existing home into a second home.
But the loan of choice for most buyers will be a conventional (non-government) loan, such as those regulated by Fannie Mae and Freddie Mac.
Other expenses to plan for
Owning a second home comes with extra responsibility. You’ll be maintaining two households, and that could cost more than you expect. So plan carefully.
Remember, affording a home is not the same as qualifying for a mortgage loan.
Mortgage underwriters look at expenses for your principal, interest, property taxes, insurance, and, if applicable, HOA dues. If these expenditures check out, they approve your loan.
You must also consider travel costs, regular maintenance, repairs, utilities, furnishings, and household items. If the second home is far away, will you need to pay someone to maintain it for you?
You might be able to offset some or even all of these costs if you rent your home part-time. But second home mortgages require you to occupy the home at least part of the year.
You should be clear on the amount of time you’re actually allowed to rent out the property — if at all — before banking on rental income to cover your ongoing costs of owning the home.
Is a rental the same as a vacation home?
Rental homes and vacation properties are financed differently.
If you can qualify for your purchase without the property generating any income, buy it as a vacation home. You’ll get a better mortgage interest rate, and qualifying is more straightforward when rental income is off the table.
However, if you need to rent out your place to afford it, your purchase becomes an investment property rather than a second home.
If you can qualify for your purchase without the property generating any income, buy it as a vacation home. You’ll get a better mortgage interest rate.
In this case, your mortgage lender will want to see an appraisal with a comparable rental schedule. This document tells the underwriter the property’s potential income.
The lender counts 75% of the anticipated rent as income to you, and the monthly mortgage, taxes, and insurance are added to your expenses when calculating your debt-to-income ratio (DTI).
Investment property mortgages often require at least 20% down, because it’s very difficult to get mortgage insurance for these purchases. Investment property mortgage rates can be 50 basis points (0.5%) or higher than rates for primary residences.
Can I use rental income to pay for my second home mortgage?
Owning a second home may not be as expensive as it first appears. The reason: potential rental income.
Some homeowners defray their monthly mortgage payments by renting out their vacation home when they’re not using it. This practice is allowed by most lenders.
The rise of Airbnb and similar services makes it easier for vacation home buyers to receive occasional rental income.
But while the rental income can support your cash flow, it won’t help you qualify for a mortgage loan. You can only use rental income to help you qualify on a true investment property mortgage — not a second home loan.
New rule changes allow partial renting
Fannie Mae, the agency that creates rules for the majority of the nation’s mortgage loans, has updated its stance on this issue.
While you still can’t use rental income to qualify for the loan, Fannie Mae now says lenders can consider a property a “second home” instead of an “investment property” even if rental income is detected.
Rental income cannot be used to qualify for a second home mortgage. But you can use rental income toward your mortgage payments once you own the home.
This is important. The rule may not come into play when you buy, but it most certainly will if you want to refinance in the future.
Second home mortgage rates are lower than those for rental and investment properties. And down payment requirements for second homes are more lenient.
Make sure the property meets all second home requirements to avoid paying higher interest rates now and on a refinance later.
Rental income has tax implications
Also note that, even though rental income won’t affect loan eligibility, the income has tax implications.
If you have tenants in your vacation home for more than 15 days out of the year, you’ll have to report the rent as income to the IRS.
But you may also qualify for tax deductions such as the mortgage interest deduction and deductions for your expenses maintaining the home. Check with a tax professional to find out for sure.
Second home mortgage options
If you’re thinking about buying a second home this year, there are a few different ways you can fund the purchase.
You may not even have to take a loan out on the second home.
These are the most popular methods of making a down payment — or paying cash — for a second home.
1. Use a cash-out refinance on your primary home
Many homeowners have built substantial equity in their primary or rental residence in the past few years. They can tap into this equity via a cash-out refinance.
For example, say a homeowner owes $100,000 on their mortgage, but their home is now valued at $200,000 due to appreciation. They could withdraw some of the equity by refinancing into a bigger loan and taking the difference in cash.
In this case, the borrower would have access to a substantial down payment on a second home:
- New loan amount: $160,000
- Current mortgage: $100,000
- Closing costs: $3,000
- Available cash for a down payment: $57,000
Borrowers who have good credit could borrow up to 80% of their home’s current value with a conforming loan. Other loan types allow an even higher percentage.
2. Open a home equity loan or HELOC on your current home
According to NAR’s annual vacation home buyer survey, a home equity line of credit (HELOC) on a primary residence is a favorite funding source for second home buyers.
If you have enough equity in your home right now, then you could simply take out a line of credit and buy your second home outright or use the funds to make a down payment.
This option would eliminate the need to refinance your current mortgage. You would keep your first mortgage intact and add another loan with different terms.
You might want a HELOC if you have recently refinanced into a very low rate. Opening a line of credit does not affect your first mortgage payment.
Typically, applicants need good to excellent credit for a HELOC. But these second mortgages come with some interesting perks.
Once approved, cash generated from the loan is yours to use as you wish. You can use the credit available, pay it back, and then tap it again throughout your HELOC’s loan term.
Plus, you may be able to avoid the higher closing costs you’d have to pay by taking out a new primary mortgage.
If you don’t like the variable interest rates that come with most HELOCs, you could get a home equity loan that has a fixed rate.
The fixed option comes with a slightly higher rate but has better payment stability built-in, making it a good choice for some second home buyers.
3. Get a loan on the second home itself
As discussed above, another option is to get a loan via conventional financing.
Current rules allow for down payments as low as 10%, and credit eligibility guidelines can be lenient depending on the lender.
Don’t think you can qualify to buy a second home? You might be surprised.
What are today’s second home mortgage rates?
Mortgage rates are still low, by historical standards, across the board. So vacation home loans are cheaper right now as well.
To make home buying even more affordable, shop around for rates with at least three mortgage lenders. You probably wouldn’t buy the first vacation home your real estate agent showed you. Loan shopping should work the same way.
Make sure your loan officer knows you’d like to finance your purchase as a vacation home and not an investment property.
Get a quote for your vacation home purchase and be sure to shop around to get your best rate.