With more and more signs that the housing market is inching off the bottom, homeowners with good credit and lots of resources are once again asking the question: Can I afford a second home?
There's something irresistible about the dream of a vacation place at the beach, lake or in the mountains. Summer vacations, the clan gathering for holidays, a place to pass down through the generations... It's the American Dream, Act II.
The problem, of course, is coming up with the money. If you don't have a trunk full of cash, the next easiest option is to borrow against your primary residence, thus avoiding the complex issues raised by a loan application specifically to buy a second home. But to borrow against your main home, it must be worth substantially more than you owe on a mortgage or home equity loan.
To take out a new loan to buy a second home you will have to convince the lender you are an especially good risk. That's because lenders know that people are more likely to default on payments for a second home than a primary residence, or to skimp on maintenance or fall behind on property taxes or insurance.
So the first issue is your debt-to-income ratio, figured by dividing your total monthly debt payments for everything -- existing mortgage, the new mortgage, car and credit card payments, and so on -- by your gross monthly income. If the figure is less than 36 percent, you have a fair shot at a loan, if your payment history and credit rating are good. Some lenders will approve applicants with higher ratios; you'll have to shop around.
Also expect lenders to demand a down payment of at least 20 percent, possibly twice that much, or even more. A large down payment reduces the loan-to-value ratio, figured by dividing the loan amount by the property's current value, estimated by an appraiser approved by the lender. The smaller the loan relative to the value, the more likely the lender would recover what it is owed if you default and the lender must foreclose and sell the property.
You're also likely to pay a higher interest rate on a mortgage for a second home -- again, to offset the greater risk to the lender.
Discouraged yet? Don't be. After all, even if lenders are more conservative these days, they make money only if they approve loans.
To make all this easier, try this calculator from The Mortgage Professor website. In the Occupancy Type window click Second Home. Note that in the Monthly Debt Payments window you should include your current mortgage payment if you will add a new mortgage for the second home.
Also play with this calculator from SmartMoney.
Before going too far down the road, check with some lenders for down payment requirements and interest rates on second-home loans. Until then, experiment with down payments of 20 percent, 30 percent and 40 percent, and add 0.5 to 1 percentage points to the mortgage rates from the Bankingmyway.com survey.
For a sense of how lenders approach second-home applications, look at this site from Wells Fargo. It shows, for example, that it is difficult to get potential rental income included in the loan qualification calculation, a key consideration if you plan to rent out your second home part of the time.
Even if a lender will approve your loan, think about how comfortable you would be with this new financial obligation. You'll need a healthy financial cushion for unexpected repairs and upkeep, a drop in your pay, a shortfall in rental income or a jump in taxes or insurance fees.
Finally, give your dream a reality check. Many people find, for example, that they lose interest in vacationing at the same place all the time. And a second home can someday become a bone of contention among the buyer's children or grandchildren.
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