3 things you need to know about buying a second house

The real estate market is hot right now, but not all of those sales are going to primary residences. Second homes made up 15% of the new home sales in 2020, showing that purchasing a second or vacation home or even an investment property is a growing opportunity for those who can afford it.

Whether you’re looking to get a summer home, start an Airbnb business, or give your kids a place to call home, here are some quick facts to know before you get started:
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1. Know your home’s purpose before you buy

‍Maybe you’ve only just started talking about getting a winter cabin on the lake, and it is just an idea at this point. If you are fairly certain you’ll be getting a second place, but aren’t completely sold on what you’ll do with it, figure the details out now.

Why is this important? Lenders need to know what you’ll do with a home before they can give you a second mortgage. They’ll ask questions about your intended purpose and how much you’ll be in the home.

Guidelines are set in place by agencies like Fannie Mae, which states the following must happen in cases of a true “second home” mortgage:

• The owner must occupy it at least part of the year
• It is limited to one-unit dwellings (not multi-family units)
• The home must be suitable for year-round occupancy
• The owner must have exclusive control over the residence (not managed by a property agency)
• The home cannot be a rental property or part of a timeshare

Second homes can be used to make some money, such as limited, short-term rentals, but the owner must handle all of the servicing and not outsource this to a management company. They must also live there part of the year. (The income from any rental activity can’t be used as a basis for getting mortgage approval and must be reported on your taxes each year.)

If you can’t meet all of the requirements above, you may be looking at buying an investment property, which will have different guidelines than buying a true second home but can help get you money for retirement.
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2. Figure out funding

Do you have cash on hand from a settlement or other large windfall? You may already have saved enough money for an investment home.. For the vast majority of homebuyers, however, financing has to happen first.

There are a few common ways to get the money for a second mortgage, including:‍

Traditional mortgage

If you have managed your finances in a way that leaves you with a significant amount of disposable income each month, you could have the means to get a second, traditional mortgage and add that second house payment to your budget each month. This, combined with a large down payment, could get you on the way to owning both homes faster, but not everyone is in this position or wants to have two home payments each month.

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Fraction Mortgage

The Fraction Mortgage is a new way for homeowners to access large sums of money from their home equity without needing to stick to a strict repayment schedule. Depending where you live, a Fraction Mortgage will be either payment-free (in Canada) or payment-optional (in USA). Regardless of where you live, the Fraction Mortgage delivers the same benefits: you don't owe back the balance until the end of the 5 year term. This route can help you optimize cash-flow, especially if you are planning to shoulder two mortgages at once.

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Cash-out refinance

‍This requires you to get rid of your current mortgage by applying for a new, bigger amount that covers both what you owe on your first house and what you’ll need for the second. This option provides benefits such as lower rates, with loan amounts that equal up to 80 to 85% of what you had paid off on the first home. Closing costs and fees can cut into that equity, however, so shop around for the best deal.

Home equity line of credit (HELOC)

Another option that may have lower fees and give you more flexibility over time is the HELOC. Here, you can use your first home’s equity to qualify for a loan, but instead of getting a bigger mortgage that covers both houses, the cash from this HELOC can be used to fund a down payment or even buy the second house outright (depending on price.).

Some people find that HELOC funds, combined with cash savings and other retirement funds, can put a big dent in that second mortgage – or replace it altogether. You don’t have to be burdened by a second mortgage in some cases at all!

If you’re considering using a HELOC to buy a second home, check out our blog for a deeper explanation. 

Another option you may hear about is the reverse mortgage. How does a reverse mortgage compare to a home equity loan? It may not be suitable for the purpose of buying a second home, and it doesn’t have the same flexibility as the HELOC.

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3. Know the actual cost to buy

It would be great if buying a second home was as easy as flipping a switch, and some lenders make it seem that it is truly that easy. While it can be simple to get funding, you should get an accurate idea of the total price tag before committing. Similar to buying a first home, you need to be armed with the right information to get the lowest rate and pay fewer fees.

• Run your credit report and check your credit score to see that you are in a good position to be qualified. For a traditional mortgage, this is a must and can help you save time by catching issues before you apply. Raising your score a bit before buying may help you get better rates, as well.
• ‍Have some money saved. If you remember what it was like buying your first home, you know that you’ll need money for a down payment, fees, and closing costs. On a $200,000 home, just the down payment can be $6,000 or more, so look at how you’ll fund those extras. (This is where the flexibility of a HELOC can come in handy.)
• ‍Don't forget mortgage insurance. If your lender requires it, you'll have to spend a little more on these monthly costs. A larger down payment may help waive this requirement, which is another reason to pay more cash upfront.

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Should I use my home equity in retirement?

No one can tell you how to live out your later years, but it’s fair to say that you probably want to be comfortable and not have to worry about money. A second home purchase can support these goals by:

• Giving you space to explore new places and pursue goals
• Helping you spend time with family (especially in another location)
• Providing another source of income
• Offering an investment vehicle that can grow in value over time

For some people, the only way to enjoy these perks is to use their first home to buy their second. With home equity solutions, like the Fraction Mortgage, you explore the reality of a second home on your terms, in your own time.

You have the flexibility to use the loan payout however you see fit, in addition to buying the home. You may even consider using a Fraction Mortgage to consolidate debt!