Purchasing a vacation property is a big decision that can come with big expenses. Once you’ve decided why you should buy a vacation home, the next step is nailing down the cost and determining whether you can afford it.
Vacation home financing is different from financing your primary residence. Mortgage lenders and the IRS will treat your purchase differently depending on how they categorize it—as a second home or an investment property.
Here’s what to know before jumping in.
To categorize your home, the IRS will look at different factors (and may even define them differently). In general: An investment property yields rental income—whether from tenants or short-term guests—while a second home is for your own personal use. It may be easier to take out a mortgage for a second home than an investment property, but there could be tax trade-offs.
This tends to get complicated, so we’ll break down the major points. (Be sure to consult with a licensed financial advisor or accountant on your specific situation before moving forward.)
Unless you’re intending to buy your vacation home with cash, you’ll need a mortgage. Lenders are generally more fastidious when approving a second home mortgage. They tend to consider them secondary to your primary home mortgage—meaning you’ll have to pay the first one back before the second if you default on both loans and go into foreclosure.
Keep in mind that both rental properties and second homes are ineligible for government loans, like an FHA, USDA, and VA loans.
Investment properties usually require more stringent qualifications, higher down payments, and higher interest rates than second homes. This is because investment properties are considered higher-risk—if you run into financial trouble, you’re more likely to walk away from a home you don’t live in than one you do.
Second homes usually receive better mortgage interest rates and require lower down payments than investment properties.
Lenders typically require that a second home be at least 50 miles away from your primary residence, while an investment property is less than 50 miles away—because you aren’t likely to vacation in a home so close to where you live full-time. Being dishonest about your intentions is considered occupancy fraud.
Understand your mortgage loan options for buying a vacation home.
There are seemingly endless locations to purchase a vacation home—from the coast to the mountains, popular tourist spots to unexpected places. However, if your primary goal is to generate the maximum rental income, consider sticking to destinations that will help you achieve that.
Our annual list of the top 25 places to buy a vacation home is a great tool to narrow and simplify your home search. In this roundup, we compile market data of destinations across North America ranked by cap rate (a forecast of your ROI), so you can better picture your home’s potential.
The amount you’ll put down on your vacation home depends on the type of home loan you use. Investment property loans, which are specifically intended for properties that will generate income, typically require a 15–20% down payment. Conventional loans allow you to put as little as 10% down on a second home, as long as you have a minimum credit score of 680.
Most lenders consider 650 as a good credit score. If you score even higher (like 680 or above), you may be eligible to put less money down. For instance, if you apply for a conventional loan with a credit score of 680, you may only need to put down as little as 10%. Higher credit scores make it more likely to qualify for a loan. Plus, it can mean lower interest rates.
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