Thinking About Buying a Second Home? Here's How It Works

Buying a second home has become a popular option for some Americans, and it’s easy to see why. Second homes can serve as a private getaway, a source of rental income, or a retreat for friends and family. And, with increased opportunities to work remotely, you could even use a second home as a place to live whenever you need a change of scenery or more space.

Reasons to buy a second home

Depending on how you intend to use your second home, there are certain financial implications.

Vacation home

Owning a vacation home means you’ll always have a place to stay when you visit your favorite out-of-town spot. You can make sure it has everything you need to be perfectly comfortable, and keeping an extra set of clothes and toiletries at your second home means minimal packing when you want to get away.

As for the financial implications, certain expenses associated with owning a vacation home might be tax deductible. Mortgage interest is deductible under the same rules as a primary residence as long as you don’t rent out the property.

You can typically deduct state and local property taxes too, subject to the usual rules capping this deduction at $10,000. These deductions will only save you money if you itemize.

Read On: How to Buy a House: Step-by-Step Guide

Rental property

If you want to buy a second home to use primarily as a rental property, lenders and the IRS will classify it as an investment property. Owning a rental property can come with a number of perks. It acts as a passive income source and allows you to take tax deductions that can offset ownership costs.

These are a few of the rental expenses investment property owners are allowed to deduct:

• Advertising
• Cleaning
• Maintenance
• Insurance
• Mortgage interest
• Management fees
• Utilities

How to buy a second home

Here is a general step-by-step process to follow when buying a second home.

1. Choose your reason

Make sure you know the primary reason you’re buying a second home. Your property requirements and desired purchase price can vary depending on whether you plan to use the second home for vacation or investment purposes.

For example, if you’re looking into a vacation home, you’ll want to find a home in a location that you know you love and will visit often, along with a floor plan that will allow you to relax while doing your favorite activities.

However, if you want an investment property, you should look for a tenant-friendly neighborhood with reputable schools, a robust job market, and affordable monthly rent.

2. Get pre-approved

Obtaining mortgage pre-approval lets you see how much you can borrow. It also provides you with an estimate of your monthly mortgage payment to help you stay within your budget.

Once pre-approved, you can compare different mortgage loans. You’ll most likely need to use a conventional lender as government-backed mortgage programs are relatively strict when it comes to vacation homes and investment properties.

Use our mortgage pre-qualification calculator to determine how much house you can get pre-approved for.

3. Hire a real estate agent

A real estate agent can make the house hunting process a lot easier. For instance, a good agent can:

• Show you the most relevant properties currently available
• Inform you about houses coming to the market soon
• Help you determine a fair market value for your desired property type
• Tell you what neighborhoods prohibit short-term rentals
• Negotiate with the seller

Ask your family and friends if they can refer you to a real estate agent. You can also interview several agents to get a feel for their personalities, working styles, and level of experience.

4. Tour home listings

To find a second home that best fits your needs, take the time to tour properties and pay attention to the following:

• Necessary repairs and improvements: Look for any repairs and capital improvements that you’ll need to pay for out of pocket. If you ask, the seller may even pay for the repairs or lower the purchase price.
• Quality of the neighborhood: Determine if the surroundings are secure and offer sufficient privacy. You should feel safe leaving your property unoccupied for several days or weeks. If it’s a rental property, try to determine if the community will attract high-quality tenants and guests.
• Occupancy rules: Some neighborhoods have strict occupancy rules. Find out if your intended dwelling use complies with the rules.
• Amenities and services: Deciding if the neighborhood and city have sufficient amenities is vital. For instance, you may want a community swimming pool or easy access to public transportation. Come up with a list of desired amenities before touring homes to narrow your focus.

5. Make an offer

After finding an excellent property that fits your needs and budget, it’s time to make an offer. Your agent can help you create the offer and negotiate any contingencies.

If necessary, the agent can also assist with counteroffers if the seller doesn’t accept your initial bid.

6. Close on the property

Once the seller accepts your offer, your lender will conduct an appraisal and review your finances to complete the financing process.

You’ll make the necessary down payment, obtain homeowners insurance, and sign the closing documents to confirm your rate and term.

Pros and cons of getting a second home

A second home can provide convenience, enjoyment, and income, but it’ll also come with additional expenses and responsibilities.

Pros

• You can use it as an investment. Whether you rent it out for a few days a year or as a full-time investment property, a second home can provide an additional source of passive income. If the property appreciates significantly, you can also sell it for a profit later on.
• You might get a tax break. If you’re paying mortgage interest and property taxes on both your primary residence and your vacation home, you’ll be more likely to benefit from itemizing deductions on your tax return. Investment properties also come with tax benefits akin to those for running any other business.
• It can simplify your vacation planning process. If you like to visit the same destination frequently, you might enjoy not having to book a place to stay every time you travel.
• You can retire there later on. If you know you want to retire somewhere else, buying a second home there now can give you a head start and make your transition easier later.

Cons

• No investment is a sure thing. Make sure your finances are strong enough to withstand long-term ownership of a second home, especially if the rental or resale markets weaken.
• You’ll have to shoulder additional costs. If you aren’t paying cash, a second home comes with borrowing costs. You’ll also incur expenses for maintenance and property taxes. Expect to pay higher insurance premiums than you would on a primary residence, too.
• You’ll have to deal with occupancy rules. Lenders, local laws, and homeowners associations may restrict how you can use your property, including how often you can rent it out and the length of each rental term.
• You’ll have less money for other things. You might get tired of vacationing at your second home but have so much money tied up in it that you can’t afford to travel elsewhere. Maintaining a second home could also compromise your ability to meet other financial goals, such as saving for retirement.

Can I afford a second home?

The purchase price isn’t the only cost you have to factor in when purchasing a second home. There are several upfront and recurring costs, such as closing costs and property taxes, that can eat up a significant portion of your budget.

Down payment

The amount of the sales price you finance determines your monthly interest and principal payment.

If you don’t make a qualifying down payment, you’ll have to pay private mortgage insurance premiums until you have sufficient home equity.

Closing costs

To finalize your second home purchase, you’ll also need to pay closing costs. The costs are generally 2% to 5% of the loan amount and include these expenses:

• Origination fees
• Home appraisal
• Credit report fees
• Title fees
• Escrow funds

Property taxes and HOA dues

You’ll need to pay property taxes on two homes now. Depending on your location, the property taxes for part-time residents can be different than what full-time residents pay.

If you want to live in a subdivision with a homeowners association, you'll also pay mandatory membership dues.

Also Read: Rental Property Tax Deductions: A Comprehensive Guide

Homeowners Insurance

Homeowners insurance is another cost to factor into your budget. The lender will create an escrow account for your insurance and property taxes and use the funds from it to pay those bills on your behalf.

If you'll earn investment income, you should also consider a landlord insurance policy.

Investment income tax

You’ll also need to report your rental income on your tax returns. It’s possible to deduct certain expenses to minimize your tax liability. Your tax preparer can help you navigate the reporting process.

Maintenance

One downside of buying a second house is having to maintain two properties. You may need to make some upfront repairs and renovations before you or a tenant occupies the home. If you don’t perform these repairs by yourself, you’ll need to hire a property management service — which is another expense.

You’re also responsible for ongoing property maintenance. Short-term rentals will require cleaning between guests.

Travel time

Visiting your second home requires time and money. You must decide if the commute is worth the potential benefits.

Qualifying for a second home

If you’ll be taking out a home loan for your second property, you should know that the interest rates and qualification standards are higher than those for a primary residence.

Your interest rate will be 0.25% higher on a vacation home if you put down less than 15%. On an investment home, the rate will be 2.125% to 4.125% higher. The larger your down payment, the lower the rate premium.

Here are the lender requirements for second-home purchases as established by Fannie Mae and Freddie Mac:

Credit score: 680

The minimum credit score to buy a second home is 40 points higher than the minimum needed to qualify for a conventional loan on a primary residence.

Debt-to-income ratio: 45%

The maximum debt-to-income ratio to buy a second home is 45%. With this DTI, you’ll likely need compensating factors such as more months of cash reserves, a larger down payment, or a higher credit score to purchase a second home.

Down payment: 10% to 15%

The minimum down payment on a vacation home is 10%. On an investment home, it’s 15%.

Reserve payments: 2 to 6 months’ worth

At a minimum, you’ll need enough money in the bank to cover a few months’ worth of principal and interest, hazard insurance, real estate taxes, and, if applicable, homeowners association dues.

On a vacation home, lenders require you to have two or 12 months’ worth of cash reserves depending on your down payment, credit score, and debt-to-income ratio. For an investment property, it’s six or 12 months’ worth.

Other ways of financing a second home

Getting a mortgage isn’t the only way to finance a second home. If you have enough equity in your first home, you could use it to purchase, or at least make a down payment on, your second home.

Tap into your home equity

Best if: You won’t get a lower interest rate by refinancing your primary residence.

Maybe you already refinanced your main home at rock-bottom rates and refinancing again would mean paying a lot in closing fees. A home equity loan or home equity line of credit (HELOC) could allow you to access up to 80% of your home equity without affecting the rate on your first mortgage.

One thing to remember: home equity loans and HELOCs usually have higher interest rates than first mortgages, but you can use the money however you want.

Use a cash-out refinance

Best if: You’d get a lower interest rate on your primary residence mortgage.

Cash-out refinancing can be a great way to take advantage of lower interest rates while pulling out some of your accumulated equity.

For example, if you owe $100,000 on your mortgage and your home is worth $500,000, you could use a cash-out refinance to take out $300,000 and buy another house. Since you’d then be paying cash for your second home, you wouldn’t be subject to stricter underwriting, higher interest rates, or lender restrictions on how you could use the property.

Credible can help you easily find the latest rates for your next cash-out refinance. Compare multiple refinance rates from our partner lenders in just a few minutes — all without leaving our platform.

Amy Fontinelle contributed to the reporting of this article.