You’ve spied a cozy bungalow for sale in your favorite beach town, and it hits you—wouldn’t it be great to purchase this oasis yourself? Yet before you get ready to make an offer, consider this: A mortgage on a vacation home works light years differently than a loan for a primary run-of-the-mill residence.
So before you head down this enticing path of purchasing a home away from home, check out this latest installment of our Guide to Buying a Vacation Home. Here, we highlight everything you need to know on the mortgage front so you can sail through the process and into your own personal retreat without a hitch.
Why vacation home mortgages may incur higher costs
Mortgages on vacation homes often require higher down payments and may have higher interest rates and property taxes, depending on the location. Why? Because financing a vacation home requires mortgage lenders to take on more risk than they would with a regular home in a variety of ways, says Steve Darnell, first vice president of sales at Flagstar Bank.
For one, vacation homes are often vacant, or rented out to tourists who may have less of an interest in maintaining the place in pristine condition.
“Occupied properties are considered less risky than rental properties, where no one is on-site with a vested interest in caring for the property,” Darnell explains.
If the buyer of a vacation home also has a mortgage on a primary residence, this poses another type of risk that the buyer’s finances might be stretched too thin over two mortgages.
“It might be fine in good times,” Darnell says, “but challenging for the homeowner to keep up with payments in a down economy.”
The location of a vacation home could pose yet another liability. Many popular vacation spots are susceptible to natural disasters, like hurricanes and flooding. Even with insurance, Darnell says, “lenders can face losses.”
All this risk means home buyers may have to pay a little more for their vacation homes in the form of a higher down payment, higher interest rates, and higher insurance premiums.
How much is a down payment on a vacation home?
While it varies by lender, according to Darnell, conventional mortgage programs that might typically need only 3% down on a primary residence will require a minimum of 10% down on a vacation home. If you plan to rent out the home rather than enjoy it yourself, that down payment could go up to 15%. In addition to having a higher down payment, mortgage interest rates on vacation homes could also be higher.
Also, not all mortgage products that are available for buying a primary residence are available for a vacation home purchase. For example, FHA and VA loans can’t be used to buy a vacation home, says Sherry Graziano, senior vice president and mortgage transformation officer at SunTrust Bank.
Why you must disclose how the vacation home will be used
“When a homeowner wants to purchase a vacation home, they must declare how they intend on using it at the time of application,” Graziano adds.
There are a few ways a vacation home can be classified:
- Primary residence, where the homeowner lives most of the year
- Secondary residence, which is rented out for no more than 180 days a year
- Investment property, which is used strictly as a rental to generate income
If the occupancy type changes from the terms of the initial mortgage, homeowners should consider contacting their lender, since the home may need to be refinanced to change the mortgage terms to match its new purpose.
While refinancing a vacation home may seem like a pain, in many cases the change could be beneficial. For example, Graziano says, if a vacation home was initially purchased to be used as a rental property but the owner later decides to make it the primary residence, refinancing could bring a lower interest rate, and may qualify for a different loan product (like an FHA or VA loan).
Your property tax and insurance bills could be higher
Vacation homes may also come with a higher property tax bill than a primary residence, Darnell says. He urges home buyers to make sure they understand the tax rates, which vary by state and locality, especially if they’re buying a home in a different state that they may not be as familiar with.
Along with different tax rates, there could be different rules and laws for real estate fees and expenses, Graziano says.
Closing costs, usually 2% to 7% of the home’s purchase price, also vary, and some states have higher transfer taxes, the fee for passing a property title from one person to another.
Homeowners insurance could also be as much as 20% higher on a vacation home, especially if it is rented out.
Mortgage pre-approval for a vacation home
Due to these higher costs, experts recommend that vacation-home buyers get pre-approved for a mortgage. That’s where loan advisers review a home buyer’s loan application, which includes the individual’s income, assets, credit, and liabilities to recommend the best-suited mortgage product.
“It is always best to have a mortgage pre-approval in hand before you sign a purchase agreement,” Darnell says. “That puts you in a better bargaining position in bidding on a home.”
He suggests checking with multiple lenders to ensure that you’re being offered a competitive rate and loan terms.
On top of the monthly mortgage payment, taxes, and insurance, Graziano says vacation-home owners need to budget for the big picture, and factor in operating costs, maintenance, repairs, utilities, and “any ancillary services for sustainable homeownership.” She says these costs are sometimes overlooked.
“Purchasing a vacation home can be exciting, but it’s important that homeowners are financially confident and have budgeted for all related expenses,” she says.
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