Are you sick of pouring money into summer rentals or booking vacation houses online, sight unseen? If you’ve already got the mortgage on your primary residence set and within your budget, you may be ready to invest in a second home. Here are some ideas on how to get an additional mortgage to potentially purchase another home.
Considering All the Costs
If you already own a house, you understand that the costs of home ownership go beyond mortgage payments. Remember that you’ll now have a second set of costs, including taxes, insurance, maintenance, utilities, and the cost of travel to the second location.
You may also face some expenses with a vacation property that you wouldn’t face with a primary residence. For example, a house on the beach might need flood insurance to protect it against hurricanes.
All of these costs factor in on top of a second mortgage payment. Before you dive into owning a second home, consider whether or not you can afford the additional costs.
Determining if You Want a Vacation Home or Rental Property
Before beginning to shop for a mortgage, you’ll need to decide whether you want to potentially earn rental income on the property. The answer to this question will determine the type of mortgage you qualify for.
However, if you need rental income in order to qualify for the additional home purchase, you may need to identify a renter and have a fully executed lease among other documents to show the lender the source of additional income. Keep in mind that the lender may only use a certain percentage (likely 75%) of the lease amount as a credit towards your qualifying income.
To qualify for a rental property loan, lenders will likely require a higher down payment, typically at least 20% or more. Non-owner occupied loans allow you to use the home when it’s not rented.
Factors to Qualify for a Mortgage
If you’re ready to buy a home, and you’ve decided what type of property you’re looking for, you’ll want to consider many of the same factors needed to secure a first mortgage.
Credit report and FICO® score: Your credit report is essentially a report card that shows lenders how responsible you are about managing your debt, including your first mortgage. It shows whether you make payments on time and whether you’ve missed payments or defaulted on debt in the past.
Your FICO score is a number that reflects your consumer credit risk. Make sure that you keep your credit score healthy by making on-time payments. Also check your credit report to make sure everything has been reported correctly. Mistakes can drag your score down, so it’s important to alert the credit reporting bureaus immediately if you find incorrect information.
Debt-to-income ratio: Your debt-to-income (DTI) ratio is a measure of how much debt you carry each month compared to your monthly income. If you have $2,000 a month in debt payments and make $6,000 a month in income, your DTI is $2,000/$6,000, or 33%. If your DTI is too high, lenders are less likely to give you a mortgage, or you may not be able to secure a mortgage with favorable terms. The DTI required by your lender can vary based on factors such as your credit score, type of home, and the size of your down payment.
One way to get your DTI low is by paying off old debts and avoiding taking on new ones. You may also consider refinancing loans you already have, including the mortgage on your first house, to take advantage of potentially lower interest rates. A lower interest rate could mean paying less over the life of the loan, which could help you lower your DTI sooner than you thought.
If you are purchasing a rental property, and you can provide a fully executed lease agreement and other supporting documentation the lender may require, it is likely that the lender will credit you with 75% of the monthly lease amount towards your qualifying income.
Down payment: Required down payments on second homes are typically higher than on primary residences. For a second home purchase, lenders may require a down payment of at least 10% or more. If you put less than 20% down, you may be required to have private mortgage insurance (PMI), which protects the lender if you stop making payments.
The more you can pay upfront with a down payment, the more favorable your mortgage terms are likely to be. Your interest rate and monthly payments may be lower, and if your DTI or credit score is less than ideal, a higher down payment could potentially help you compensate for these factors.
Though making a large down payment can be a financial boon, you may want to make sure that you don’t deplete your savings so much that you no longer have extra cash to cover other expenses like closing costs .
Income and assets: Your lender will typically want to see that you have two years worth of steady and ongoing income to qualify for a mortgage. They also may want to see recent statements from any monetary assets you have such as a checking account, savings account, CD, IRA, 401(k), etc. For well-qualified borrowers, lenders will want to see reserve funds. Amount of required reserves will vary from lender to lender and loan program to loan program, but each month of reserves is equal to one month’s worth of payments on your first and additional mortgage. One month of mortgage payments is defined as principal, interest, taxes, insurance, and other miscellaneous costs (such as flood insurance or HOA dues).
It’s usually a good idea to shop around. As you search for an additional mortgage, consider checking out multiple lenders to make sure you’re getting the best deal for you on interest rates, terms, and fees.
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