Mortgage lenders make no bones about it: They are tougher on second-home loan applications than on primary-home loans. Why? Because the finances of a second-home buyer are, by definition, stretched thinner. The result is that second-home rates traditionally run one-quarter to one-half point higher than those for first residences. Ditto for origination points on vacation-home loans.
That said, however, the current environment for second-home lending is about as lenient as it has been in years. Banks are healthy again and a rebounding real estate market has them all rushing into the market at once. The result: heightened competition -- especially in the second-home arena. "The typical profile of a second-home owner is someone more affluent than a single-home buyer," says David Totaro, chief marketing officer for Dime Savings Bank of New York. "That's the type of person we want to do business with."
Using a Home-Equity Loan
With interest rates still at relatively low levels, many lenders will encourage you to take out a home-equity line of credit on your primary residence to fund all or part of your second-home purchase. Watch your step here. Most home-equity lines of credit float a point or two higher than the prime rate, so you could end up repaying this piece at a much higher interest rate than if you had simply taken a mortgage for the entire amount. Plus, unlike mortgage interest, which is deductible on up to $1 million of debt on your first and second homes combined, the home-equity cap is $100,000. (You get a break on $1.1 million total.)
Whatever you do, don't bank on starting with a home-equity loan and taking out a mortgage at a later date. A little-known IRS rule states that you have just 90 days from purchase to secure a mortgage against a principal or vacation residence, notes New York CPA Paul Kamke. Do it later and you can't deduct it at all.
Landlording and Mortgages
Lenders are still sticky when it comes to renting out your second home. Some lenders won't even write those kinds of loans; they have a hard time selling mortgages on investment property in the secondary market. If you find a lender that will, expect it to scrutinize you more carefully than if you were not a landlord.
At a minimum it will want to see proof that you're actually going to generate a decent cash flow. Often, the lender will ask for a cash flow statement for a property showing its rental history. In condo communities, management companies often provide them. If one isn't available, you'll need to get a second appraisal, comparing the rents and occupancy rates at similar homes. This will run an extra $300 to $600.
And don't count on your bank to take all of a home's estimated rental income into consideration. Even for a property with a long rental history, most lenders will only consider 75% to 80% of it. Some even take 75% after netting out your costs.
If you don't need the rental income to meet the mortgage industry's ratios, you may not want to mention to your lender that you're thinking of renting. We're not suggesting that you lie on your mortgage application. That's a federal offense. But if you happen to change your mind, well, that's another story. "A lot of people go in under the guise of buying vacation property for personal use only to turn around and rent it out," says Keith Gumbinger, of mortgage researcher HSH Associates. "I have never heard of people getting caught."