Home sweet (second) home: How to finance a vacation property

When Graham Gullans bought his Chatham holiday home last year, he knew straight away that he would finance it with a mortgage. “Mortgage rates were so low they offered a really compelling reason to buy a second home,” said the 37-year-old tech executive, whose primary residence is in Boston.

Gullans took out a 2.75% mortgage to purchase the property, which consists of a main house and a separate shed totaling four bedrooms and five bathrooms, for $1,176,000.

Today, however, deciding how to pay for a vacation home can be more difficult. According to Freddie Mac, a 30-year fixed-rate mortgage averaged 5.25% as of May 19, down from 3% a year earlier. Higher interest rates, which translate into higher mortgage payments, reduce a vacation home buyer’s purchasing power. Plus, with limited inventory and strong buyer demand, the market is more competitive than ever, so some buyers are getting more creative about finding the perfect weekend spot.

“The local residential market is very competitive, so people are doing things a little differently,” said Mary Mullin, wealth management adviser for Merrill Lynch Wealth Management in Boston. “Ideally you want to enter with a cash offer.”

Mullin said that in the past, if someone owned a house in Boston or the suburbs and wanted to buy a house in Cape Town, they would do a cash refinance. But despite the fact that exploitable equity — the amount homeowners can access while retaining at least 20% of their home equity — rose 35% in 2021, to an overall total of nearly 10,000 billion, according to mortgage data and technology firm Black Knight Inc., many vacation home buyers don’t have enough equity in their home to pay for a second property. Plus, Mullin said, many of his clients don’t want to refinance now anyway because interest rates are so much higher.

But a home equity line of credit (HELOC) allows homeowners to tap into the equity in their primary home while keeping the underlying first mortgage in place. And even if that equity isn’t enough to pay the full purchase price of a vacation home, it could allow a buyer to increase their down payment to better compete with other bidders.

Another option is to liquidate the investments to generate the cash needed to pay for a holiday home, but this may incur a tax liability. “People don’t want to cash in a wallet and pay capital gains tax,” Mullin said. The solution: a line of credit secured by the investment portfolio, which gives buyers the option of making a cash offer. Then, after closing, they can mortgage the vacation home and pay off the line of credit. “It’s a good strategy,” Mullin said.

Yet many vacation home buyers will finance their purchase with a traditional mortgage. Patti Lotane, mortgage loan officer for Cape Cod 5 in Chatham, said interest rates at the state-chartered savings bank are the same for primary and vacation homes. Applicants must deposit a minimum of 10% or 20% to avoid private mortgage insurance. Those who need rental income to qualify for the mortgage, or applying for a jumbo loan, will need a higher down payment — up to 30%, Latona said.

In January, the Federal Housing Finance Agency announced increases to Fannie Mae and Freddie Mac’s initial fees for second home loans, effective April 1, 2022. These fees make financing a second home with a mortgage that will be sold to Fannie or Freddie lot. more expensive.

“Beginning with deliveries to Fannie and Freddie in April, new fees apply to second homes,” said Bill Banfield, executive vice president of capital markets for Detroit-headquartered Rocket Mortgage. “They range from 1⅛ points to 4⅛ at the highest loan-to-value ratio [LTV] and the lowest FICO score.

For someone with good credit and an LTV of 75%, Banfield said, the fee would be 2⅛ points, or $8,500 on a $400,000 mortgage. “It’s gotten in the way of financing new second home purchases a bit,” he said.

Allison Cameron Parry, a realtor with Douglas Elliman Real Estate whose market area is Nantucket and Martha’s Vineyard, said for purchases up to $6 million, her buyers always use some sort of financing. At higher prices, she said, many are paying cash.

Its customers are also getting creative with financing their vacation homes. Some ask their parents to co-sign their loan so they can qualify, while others buy second homes with friends or family members to split the costs. Those planning to use their vacation home as a business or investment property by renting it out may, subject to Internal Revenue Service rules, qualify for a 1031 or similar exchange. Cameron Parry said a recent client did just that, selling a condominium on Cape Cod and swapping it for a house on Martha’s Vineyard while deferring the gain and deferring capital gains taxes on the sale.

The method you choose to finance a vacation home will ultimately depend on your personal financial situation and risk tolerance. That’s why it’s wise to consult an accountant or financial planner right from the start.

“If you’re trying to figure out whether you should get a mortgage, liquidate savings, or take money out of a retirement account, first look at what it’s going to cost you in taxes,” said Mullin, the adviser. in wealth management. “So look [your] monthly cash. You may be able to afford the 20% down payment, but how will the payments impact your monthly budget? »

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