Once you have a clear understanding of why to buy a vacation home, the next step is understanding the cost—whether you can afford it.
Budgeting for a vacation home is different than your primary residence, in part because mortgage lenders and the IRS will treat your purchase differently based on whether they categorize it as a second home or an investment property.
Mortgage lenders and the IRS look at different factors to categorize your home (and may define them differently), but generally speaking, an investment property is rented out to generate additional income while a second home is for your own personal use. Taking out a mortgage may be easier for a second home than an investment property, but there are trade-offs when it comes to how you file your taxes.
This can get a little complicated, so bear with us. (And our lawyers would like us to clarify that we aren’t financial advisors or accountants, so please consult the licensed experts after reading our general overview.)
Vacation home mortgages
Unless you’re intending to buy your vacation home with cash, you’ll need to apply for a mortgage. Lenders are more particular about approving a second home mortgage because they’re usually considered subordinate to your primary home mortgage—meaning you’ll have to pay the first one back before the second if you default on the loans and go into foreclosure.
Keep in mind that both investment properties and second homes are ineligible for government loans (like an FHA, USDA, and VA loans).
To qualify for a second mortgage, you’ll need:
- A debt-to-income ratio (DTI) below 41%: This percentage is determined by dividing your monthly debt by your gross monthly income. It essentially tells lenders how much of a financial safety net you have, and if you’d be able to still pay off your loans in the case of unforeseen circumstances.
- A good credit score: Having a healthy credit score is always a good idea, but it’s especially important when buying a vacation home. The higher your score (a 620 or up is considered pretty good) the more likely you’ll be to qualify for a conventional loan (and pay lower interest rates).
- Cash reserves: In addition to your DTI, lenders may look at how much money you have tucked away. Buyers with a savings account, a growing IRA, an emergency fund, and a college fund appear safer than a borrower with little money to their name.
Mortgages for investment properties
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.
Mortgages for second homes
Second homes usually receive better interest rates and require lower down payments than investment properties, but being dishonest about your intentions is considered occupancy fraud.
Lenders typically require that a second home is at least 50 miles away from your primary residence, while a property less than 50 miles away is considered an investment property—because you aren’t likely to vacation in a home so close to where you live full-time.
Learn more about mortgages in our guide to financing a vacation home.
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