If you own a primary residence (the home you live in) but would love to own more real estate, you can! There are several ways to get the financing necessary to buy a second home or to invest in real estate.
Because the loan terms are a little stricter, it’s important to understand how you can qualify for a loan for either a second home or investment property.
Here’s what you must know.
What Type of Property will you Buy?
Before you apply for financing to buy a home other than a primary residence, you must decide how you’ll use the property as this will have an effect on your financing options.
The most common options include:
- Second home – A second home could be a home you use for vacation, or you live in for part of the year. To qualify as a second home, it must be at least 50 miles away from your primary residence for most lenders.
- Investment home – When you buy a home, keep it and rent it to tenants, it’s an investment home. You can collect monthly rent payments and use them to offset the cost of the home, hopefully making a profit between your rental income and expenses.
- Fix and flip – If you like to buy undervalued homes, fix them up and sell them, you’ll need a different type of financing. Most investors use a rehab loan to cover the cost of buying the house and renovating it. They typically flip the property within 6 months to decrease the cost of holding the home.
Financing Options for a Second Home or Investment Property
Finding financing for a home other than your primary residence can be slightly tougher than when you got financing for your home.
There’s one reason.
The risk of default.
You are more likely to make your mortgage payments on time for the home you live in, than a second home or investment home. If things got tough financially for you, the first thing to go would likely be your mortgage for any other properties.
This doesn’t mean you can’t find financing for these properties, they just might have a higher interest rate, more fees, or stricter guidelines.
You can’t use government-backed financing for any home but your primary residence, this includes FHA, VA, and USDA financing, but here are some other options.
If you have great credit and you pay your primary mortgage payments on time, a conventional loan may be a good option. They don’t have the requirement that the home must be your primary residence and you might be able to use rental income as qualifying income if you have an active lease on the property.
Home Equity Loans
If you have a primary residence with equity in it, you might be able to use that equity to buy another home. Depending on how much equity you have, it can cover the full amount of the house or at least a sizeable portion.
Home equity loans have fixed interest rates and you receive the funds as one lump sum. You make principal and interest payments on the loan from the start, and they usually have a term of 20 years. You can borrow up to 80% of the home’s current value minus any outstanding first mortgage liens.
Home Equity Line of Credit
You also have the option to take out a HELOC rather than a home equity loan. It has the same premise – it’s a second mortgage on your primary residence. You can borrow up to 80% of the home’s value minus any outstanding first mortgage balances.
A HELOC is a line of credit, so you don’t receive the funds as one lump sum. You can withdraw from the funds as you need, and you only owe interest payments on the funds withdrawn for the first 10 years.
You can make full principal and interest payments if you want, which then allows you to reuse the line if you want, much like a credit card. The interest rate on HELOCs is variable, though, so keep that in mind as you decide.
You might also be able to find private lending options, such as online crowdfunding or funding from a private lender. These lenders set their own requirements and parameters, but typically they charge higher interest rates and fees to make up for the risk fo default and to make the investment worth it.
Qualifying for Financing for a Second or Investment Home
When you’re trying to buy a second or investment home, the qualifying requirements are tougher, but not impossible to meet.
Each loan and lender has different requirements, but here’s what you can expect on average.
You’ll need to prove that you can handle multiple loans, especially if you have a mortgage on your primary residence right now. A credit score of 700+ is usually required, but you might get away with a lower credit score if you have other compensating factors.
It’s very important to pay attention to your housing history as future lenders will look closely at it. Try to avoid having any late payments within the last 12 to 24 months for the best chance at qualifying.
Large Down Payment
Most lenders require a large down payment on a second or investment home. This is to decrease the risk of default. The more ‘skin in the game’ that you have, the easier it is to qualify for the loan.
On average, lenders want a 30% down payment, but some may require more or less, it depends on the situation. The more money you invest upfront, the lower your monthly payments are and the more equity you have in the home right away.
Stable Income and Employment
Lenders want borrowers to have stable income and employment for at least the last 2 years. They also want proof that your income and employment will continue for the foreseeable future. This is why income and employment stability is so important.
If you have gaps in your employment or your income changes often because you work on commission or freelance, it could be harder to qualify.
Low Debt-to-Income Ratio
Your debt-to-income ratio also plays an important role in your ability to qualify. Your DTI is a comparison of your monthly debts to your gross monthly income (income before taxes). Ideally, you should have a DTI of 43% or less, but sometimes with second homes or investment properties it can get a little higher.
If you need approval with a higher DTI, you must have other compensating factors to make up for the risk, such as a large down payment or great credit. If you’re buying an investment property, you can also try to use the potential rental income to help lower your DTI.
High Enough Appraisal Value
Your appraisal is the one factor that can hold you back from financing a second or investment home that you can’t control. The appraised value must be at least as much as the sales price or more.
If the appraised value is less than the sales price, the lender will figure your loan amount on the appraised value, which leaves you responsible for the difference. If you can’t make up the difference in cash, you won’t be able to buy the home.
What to Look for in Financing for a Second Home
Before you take financing for a second or investment home, here’s what you should look for:
- Low rates – You’ll pay higher rates for a mortgage on a second home or investment property, but that doesn’t mean you shouldn’t shop around to get the lowest rate available to you.
- Low fees – Each lender charges different fees. Compare the total cost of the loans side-by-side to determine which is right for you.
- Good servicer – Do your research on the loan servicer. They are the company you will deal with for the life of the loan. Make sure it’s a company with a good reputation and that helps its borrowers.
Getting financing for a second home or investment property may be slightly harder than getting financing for your primary home, but there are ways. Improve your qualifying factors and ensure that you have options and can choose the lender with the lowest cost and best terms.