Interest rates and fees
Be prepared to pay a higher interest rate on a second mortgage than your initial mortgage. Second mortgages are riskier for lenders, so they charge steeper rates. You'd also pay a lower rate on a regular rate-and-term refinance or cash-out refinance.
But it takes a 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 a 20% down payment for a second home.
Second mortgages tend to have higher interest rates than first mortgages for that reason. A borrower who now has two mortgage payments to make instead of one presents a greater risk for the lender. So they compensate by charging more in interest to offset the possibility of the borrower defaulting.
Mortgage interest rates for investment properties are typically higher than rates for mortgages to buy a primary residence. Lenders consider investment property mortgages riskier than traditional mortgages, but there are steps you can take to get a lower interest rate.
The 2% rule says an investment property's monthly rent should equal at least 2% of the purchase price. According to the 2% rule, your monthly mortgage payment shouldn't exceed $3,000, and you should charge $3,000 in monthly rent. The 2% rule is more extreme than the 1% rule – basically doubling the monthly rent amount.
Because there's more risk to the lender, mortgage rates on second homes are typically slightly higher than mortgages for primary residences. Rates have increased over the last couple of months, and second home mortgage borrowers should expect to pay a bit more to get a loan.
If you take out a $50,000 home equity loan, you will receive all of the money at once and pay interest on the full amount. With a HELOC, you can withdraw money whenever you need it.
Investment properties can offer you tax deductions by claiming operating expenses and ownership. Second homes, on the other hand, can also generate rental income and tax deductions for expenses, as long as the owner lives there for at least 14 days a year or 10% of the total days rented.
A good way to remember the documentation you'll need is to remember the 2-2-2 rule: 2 years of W-2s. 2 years of tax returns (federal and state) Your two most recent pay stubs.
FHA Loan Requirements for a Second Home
The new residence must be at least 100 miles away from the old one. The current property must have an LTV (loan-to-value) ratio of 75% or less. Your situation has changed or is changing to the point of having to move into a second home. Your credit score must be 580 or better.
Debt to income ratio
The DTI mortgage requirements for a second home vary by lender, but your total debt load should be less than 36% to 50% of your gross monthly income. These limits ensure that you have enough money to pay taxes, monthly household expenses, and cover any unexpected bills that may occur.
You can deduct property taxes on your second home, but if you take a property tax deduction on your first home, you may be ineligible to claim another for your second residence. There's a limit of $10,000 per tax return (or $5,000 per person if married and filing separately).
Higher Interest Rates
Second mortgages usually have higher interest rates than first mortgages. This is because lenders see them as riskier. The higher the risk, the higher the rate. These increased rates mean higher monthly payments for borrowers.
Reasons for owning a second home
Diversify your investments: Owning a second home allows for getting beyond the usual stocks, bonds and 401(k) plan. A second home can also act as a buy-and-hold investment — real estate does tend to appreciate in value over time — and be a valuable asset to pass on to heirs.
Assuming a borrower who has spent up to their HELOC credit limit, the monthly payment on a $50,000 HELOC at today's rates would be about $372 for an interest-only payment, or $448 for a principle-and-interest payment.
While the Fed's ongoing rate cuts might reduce borrowing costs on HELOCs in 2025, a home equity loan might be a better long-term option if you expect rates to rise during your loan term. Home equity loans are a great option if you need a large, lump-sum payment to fund a large expense.
At its February 2024 meeting, the Reserve Bank Board decided to leave the cash rate target unchanged at 4.35 per cent. This decision supports progress of inflation to the midpoint of the 2–3 per cent target range within a reasonable timeframe and continued moderate growth in employment.
Although most second-mortgage lenders state that they don't charge closing costs, the borrower still must pay closing costs in some way—the cost is included in the total price of taking out a second loan on a home.
Q: Does rent count as debt to income ratio? A: If you are making rental income, 75% of it can count toward your income to lower your DTI. Those making rental payments to a landlord do not count their rent toward their DTI because it is assumed that this expenditure will be replaced by a mortgage.
The 3/6 ARM product listed above is a 30-year loan where the initial interest rate is fixed for the first 3 years (36 payments). After the initial three-year period, it is possible that the interest rate, APR, and payment may increase substantially over the remaining term of the loan.