What to Know About Buying a Second Home

Reasons to Buy a Second Home

When you're evaluating whether or not to buy a second home, it can help to start by considering some of the potential benefits:

• Personal enjoyment: One of the most popular reasons to buy a second home is to use it as a personal vacation spot. If there's a destination you want to frequent, such as the beach, lake, a ski resort or the city, buying a second home there could set you up for many convenient getaways to come.
• Rental income: You could buy a second home as a way to invest in real estate and use it as a short- or long-term rental to generate income. Just be aware that, whether you're hosting travelers or leasing to a long-term tenant, managing a rental requires a considerable amount of work and ongoing financial investment.
• Diversified portfolio: Diversification is a term for spreading your money out among different types of assets, including stocks and bonds. Real estate has the benefit of having low correlation with stocks. In other words, property values tend to move up and down independently of what's going on in the stock market. In terms of diversification, that can translate to more balanced volatility in your portfolio.
• Retirement: You could also buy a second home now in anticipation of eventually retiring there. In the meantime, you could treat it as a vacation destination or use it as a source of rental income. When it comes time to retire and you move into your second home, you could rent out your primary residence for additional retirement income, or you could sell it to downsize.

Learn more: How to Rent Out Your Home and Buy Another

Financial Considerations for Buying a Second Home

Buying a second home may sound appealing, but it can also easily spread your finances thin. Here are some things to consider.

• Upfront costs: To be sure you have the necessary savings on hand, research and add up the upfront costs of buying a second home, including earnest money, a down payment and closing costs. You may also need to include furnishings and updates to the property, depending on the home.
• Monthly expenses: Calculating the monthly expenses can be a more complicated prospect. You'll need to account for the cost of a second mortgage alongside your current housing payment. You'll also need to consider property taxes, insurance, utilities and maintenance costs. If you plan to vacation there, you'll need to factor in how much you'll spend traveling to and from the property. If you plan to rent out the home, you'll need to research carrying costs, plus the tax implications of earning rental income.
• Financing: Unless you plan to pay cash, another big factor to consider is whether you'll be able to qualify for a mortgage on a second home. Generally speaking, getting a loan for a second home can come with stricter credit and debt-to-income ratio (DTI) requirements when compared to a loan for a primary residence. You may also need to put more down.
• Other financial goals: Prospective buyers should look at their full financial picture before deciding to buy another home. For example, do you have ample emergency savings? Do you have clear retirement goals, and are you on track to reach them? Do you have any high-interest debt you should prioritize paying off before you buy?

Learn more: Homeowner Costs Beyond Your Mortgage

How Do You Finance a Second Home?

If you need to finance a second home, you have several options. Often, second home mortgages look a lot like the one you may have taken out for your primary residence. On the other hand, qualifying for a mortgage for a second home may come with stricter requirements.

Before we get into the types of financing you may be able to use to buy a second home, a word on the types of loans you typically can't use. Generally speaking, you cannot use government-backed loans, such as Federal Housing Authority (FDA), U.S. Department of Agriculture (USDA) or Veterans Affairs (VA) loans to buy a second home. These loans require that the home be your primary residence. In some cases, it may be possible to use one of these options if you plan to convert your current primary residence into a vacation home or rental and occupy your second home full time.

With that, here are some potential ways to finance a second home.

Conventional Mortgage

You can use a conventional mortgage to buy a second home, but requirements vary depending on whether you'll use the property as a personal residence or a rental. For example, rental properties often require higher down payments because they pose more risk to lenders. They also require that you have higher cash reserves for ongoing property costs, excluding the money you'll put toward a down payment.

Learn more: How Investment Property Mortgage Rates Differ From Conventional Mortgage Rates

Cash-Out Refinance

You can tap into equity from your first home to buy a second using a cash-out refinance. Refinancing can give you a lump sum of money to put toward a down payment and other costs of buying a second home.

Keep in mind that refinancing involves closing costs, and you'll also likely raise your monthly payments, since a cash-out refinance replaces your current mortgage with a larger loan. You'll need to account for raising your monthly payments on your primary residence, in addition to the monthly payments you'll take on if you buy a second home. Because that's a lot to consider, it may help to run through the numbers with a financial advisor.

Learn more: How to Buy an Investment Property With Home Equity

Home Equity Loan or Home Equity Line of Credit (HELOC)

Another way to tap into equity from your current home is using a HELOC or home equity loan, each a type of second mortgage. One benefit is that using your home as collateral can help you qualify for a lower interest rate—but you also put yourself at risk of foreclosure if you stop making payments.

Jumbo Loan

Jumbo loans can be an option when you're buying a home that's too expensive for a conforming mortgage. This could be useful if you're considering buying an expensive vacation property, for instance.

It's important to be aware that jumbo loans have stricter applicant requirements, carry more expensive closing costs and can present more overall risks to both borrowers and lenders. On the other hand, they have the benefit of sometimes offering lower rates than conforming loans.

Learn more: What Type of Mortgage Loan Is Best?

How to Buy a Second Home

If you think you're ready to buy a second property, here are some steps you can follow as you navigate the process.

Weigh the Pros and Cons

Again, it's important to do a thorough evaluation of your current financial state and weigh all the potential costs a second home could come with before you decide to move forward.

Then, balance the expenses with what you hope to achieve. For example, if your goal is to own your own slice of paradise in your favorite vacation spot, will that benefit justify the money you need to put down or the extra monthly costs—or will it jeopardize your ability to meet your other financial goals?

If your goal is to generate rental income, will the money you bring in be enough to make financial sense when considered against the carrying costs and labor involved in owning a rental?

While many of the answers may come down to personal preference and your budget, talking to a trusted financial advisor could help you evaluate how a second home fits into your greater financial picture.

Get Preapproved for a Mortgage

It's a good idea to get preapproved for a mortgage before you tour homes or get your heart set on a specific property.

Getting preapproved before you begin your home search gives you a firmer sense of what you're likely to qualify for based on your:

• Credit history
• Income
• Debt-to-income ratio
• Cash reserves

Plus, once you find the perfect home, a preapproval letter can give you a leg up on other buyers because it shows the seller that you're serious and ready to buy.

Learn more: What Factors Do Mortgage Lenders Consider?

Work With a Real Estate Agent

A real estate agent can guide you through the next steps. They'll help you find properties matched to your budget in your desired location. Then, they'll take you to tour homes and put in an offer when you find the right fit.

If your offer is accepted, the closing process is much the same as it is for a primary residence. You'll go through a due diligence period, in which you'll have the opportunity to order an appraisal, inspections, a title search and the like. Your agent or lender will help you complete the underwriting process, satisfy funding requirements, complete a final walkthrough and, finally, take possession of your new home on closing day.

Learn more: Mistakes to Avoid When Closing on a Mortgage

The Bottom Line

Buying a second home can have a lot of perks, but it's also a major financial decision. It could provide a valuable vacation retreat, a stream of income, a place to retire or a combination of the three. But be sure you consider the added costs and responsibility of owning another property before you decide.

Also, if you're considering buying, it's a good idea to keep tabs on your credit score starting months before you plan to purchase a home. Sign up for free credit monitoring from Experian for updates on changes to your credit report and score. From within your account, you can also view personalized insights on potential actions you could take to improve your credit.