Financing often is the biggest hurdle for second-home buyers and the transaction element of which they are least sure. If a second home’s rental income is needed to qualify the buyer for a loan, the property and the loan will fall into the investment category. As such, lenders will factor in anticipated vacancies, rental income, expenses and the mortgage payment when determining how large a loan can be approved. Here, RISMedia offers some basic tips for second-home financing.
Private mortgages and seller financing
If a buyer cannot meet down-payment requirements, but can afford payments, seller financing may offer a solution. One strategy to consider is a combination of a 75-percent first mortgage, a 10-percent down payment and seller carry-back financing of 15 percent. This strategy is allowed by the secondary mortgage market, which purchases second-home loans, and may enable a buyer to avoid private mortgage insurance (PMI) because the first mortgage is less than 80 percent. A private mortgage made by a relative or friend and secured by the property is another possible strategy.
Second mortgage on a primary residence
This may be a risky move if the first mortgage is not paid off. On the other hand, if the buyer is able to qualify for the loan and property is appreciating in value, the lender may feel comfortable making the loan. If the borrower cannot sustain the loan payments, one of the properties can be sold and the proceeds can be used to pay off the balance on the second mortgage.
Home equity loans
A home equity loan on a primary residence to finance some or all of the second-home purchase is another option. Since home equity loans tend to be a point or two higher in interest rates, the buyers could end up paying more than if they had obtained a mortgage for the entire amount. For high-income or high-net worth buyers, a home equity line of credit (HELOC) may be the easiest and quickest type of financing to obtain. A line of credit usually has a lower interest rate than a second mortgage and a quicker approval process.
Reacting to losses sustained during the wave of foreclosures resulting from the subprime mortgage market meltdown, FHA—along with Fannie Mae and Freddie Mac (also known as government-sponsored entities, or GSEs)—tightened lending standards for condo loans across the board. In short, these lenders will want to see a financially sound condo development with a high percentage of owner occupancy and low percentage of delinquency on fees. Furthermore, FHA loans are not available for vacation and second homes and investors. Apart from very narrow exceptions, the situation is the same for VA loans. Local lenders will be up to date on which condo developments in the market area hold GSE approval for investment and second-home purchases.