5 Terms Second Home Buyers Should Know

Are you considering purchasing a second home or investment property? Second homes are typically purchased with the intent to live in for at least part of the year or purchased as an investment to generate rental income from occupying tenants. If you've already been through the home-buying process for a primary residence, you are familiar with the requirements and costs. In second home purchases, there is a significant difference between the costs and qualifications compared to primary home purchases, as well as new terms and phrases. 

Here is a list of five important real estate terms that second home buyers should be familiar with as they start the home-buying process for a second or investment property.

1. Vacation Home

When defining a vacation home, the primary factor is that it is a property other than your residence used for recreational purposes. A vacation home can be an excellent purchase for those looking for a place to make frequent trips, those who have recently retired, and so on.

While owning a vacation home can be a dream for most, it is essential to understand the factors that can affect the ability to own and maintain a second, part-time residence. For example, compared to a first home, the downpayment on a vacation home is typically larger, around 10% more. 

Other requirements a second home buyer must be aware of include living in the home for a portion of the year, the property must be accessible year-round, and the home must not be operated by a rental or property management company. If you plan to rent out your vacation home when you're not using it, there are tax considerations to keep in mind.

2. Investment Property

When entering the market for a second property, it is vital to understand the difference between a vacation home and an investment property. Some differences include the sole purpose of the home, the mortgage rates, and the tax treatments. An investment property is only to generate income and often has a higher mortgage rate than a vacation home. 

Regarding taxes, the investment property's rental income must be included on a tax return. The upside to doing this is that the second home investor will also be able to deduct rental expenses such as maintenance, utilities, and insurance.

Many second-home buyers look to invest in properties to make additional money through investment benefits such as passive income, stable cash flow, and tax advantages. In many cases, those who use their properties as investments can generate recurring revenue with little to no effort. It can be a great way to ensure financial stability and pocket some extra cash.

3. Equity

Equity is the difference between how much your home is worth and how much you owe on your mortgage. For example, if you owe $200,000 on your mortgage loan and your home is worth $250,000, you have $50,000 equity. When buying a second home or investment property, knowing how much you owe on your current mortgage versus what the property is worth is essential in your future ventures.

You can build equity in your home in a few ways, including making a significant down payment, making improvements on your home to increase the property value, paying more on your mortgage, refinancing to a shorter loan term, or waiting for your home to rise in value. Your equity can also fall in cases where the value of your home drops at a quicker rate than you are paying down your mortgage's principal balance.

One of the benefits of buying a home or a second property is that you can build equity in it and use what you've earned later for needs such as remodels or other bills. If you have enough equity in your current home, you can use the money to make a down payment on another home or buy another home outright without a mortgage.

4. Second Mortgage or Home Equity Loan

Due to the skyrocketing cost of buying a home since early 2020, many homeowners have gained a significant amount of home equity. An option for these homeowners may be to tap into that equity by using a second mortgage to borrow against the home equity. A second mortgage is a loan that utilizes the equity in your home as collateral. Some examples may include a home equity loan or line of credit (HELOC).

A home equity loan can help make buying a second property less expensive and offer more liquidity while eliminating homeowners' out-of-pocket expenses. It could give you more cash towards the second down payment, solve financing challenges, and more.

Some risks come with taking equity out of your home to buy another property, including having multiple loan payments and higher interest rates. Before moving forward with this process, a homeowner should clearly understand their financial situation and be confident they can still handle the payments at their primary residence.

5. Debt-to-Income Ratio

When deciding to take a mortgage out on an additional property, whether with a second mortgage, home equity loan, HELOC, or other financing options, lenders will ask and look closely into your debt-to-income (DTI) ratio. This ratio takes monthly debt payments divided by gross monthly income. 

With this ratio, lenders can understand a second home buyer's ability to manage monthly payments on money borrowed. The higher your DTI ratio, the more the second home buyer is at a higher risk of default and may not be able to take on another loan. The lower the ratio is, the better your chances of maintaining mortgage payments.

For second-home buyers, lenders prefer a maximum DTI ratio of 36%, while others may go as high as 46%. Each lender's max DTI ratio changes case by case, but knowing where you land and what you're willing to pay is essential. Additional factors a lender will consider for a second home are your credit score, down payment, income, and employment status.

Emerald Isle Realty

Are you feeling more confident about entering the market? Great news! Here at Emerald Isle Realty, our staff of experienced, five-star service REALTORS® can guide you through the process of buying or investing in a second home property. Call us at (800) 304-4060 for assistance in buying/selling.