Interest Rates are Low. Time to Buy a Vacation Home?

Interest rates have been dropping for years, partly as a way for the federal government to try to boost the economy.

A 30-year fixed-rate mortgage is 3.02% as of July 2020, down from 4.53% only two years earlier, according to FreddieMac, a federal agency that backs mortgages.

Is now the time to take advantage of low home loan rates and buy a second home? Perhaps a vacation home?

Low interest rates can be enticing. But before making a down payment on a home near your favorite beach, here are some factors to consider:

Financing a Second Home

Before we get into the fun part of finding a vacation home you love, get an idea of how you’ll pay for it and what your budget will be.

A local lender can make the process faster and smoother. Local banks are likely to know appraisers and others who are familiar with the area where you want to buy, and can give you a more accurate estimate of the home’s value than someone from outside the area.

Rental Income Can Help Afterward

If you’re planning on earning some rental income from your vacation home, the potential earnings won’t help you qualify for a loan on a second home.

Rental income may only be considered to qualify for a loan if you won’t live there and will rent it out full-time. But doesn’t that defeat the purpose of buying a second home? Not if you rent it out for a few years and then move in.

Mortgages on second homes are considered more of a risk by lenders, so interest rates may be 0.25 to 0.5 percentage points higher than for a primary home. The thinking is you’re more likely to not pay a mortgage on a second home if money gets tight, and could default on the loan.

A higher down payment will be needed. Expect to put at least 10% down, compared to 3% down for a primary home with a conventional mortgage.

Lenders may also require having enough cash reserves to cover a few months of mortgage payments.

Higher credit scores may be needed to qualify for a loan. The amount you owe on the loan as a percentage of the home value, called the loan-to-value ratio, may need to be lower than it would for your first home loan. That’s when a bigger down payment can help.

To pay these extra costs, you may want to use the equity in your primary home. A home equity loan or line of credit can help, as can a cash-out refinance where you borrow more than is owed on your first home and take the extra money as cash. However, if you don’t need expected rental income to qualify for a second home loan, then you could make some extra money by renting it out from time to time. Just make sure the homeowners association, if there is one, allows rentals.

Choosing Where to Buy in a Down Economy

Housing markets obviously vary by location. Beach homes and other sought-after spots will likely be much more expensive than remote getaways that aren’t big vacation getaways.

A weakening economy can cause owners of vacation homes to sell if they can’t afford them any longer. However, low interest rates and a higher interest in second homes during a pandemic can increase interest and raise home prices.

To get the most use out of a vacation home, it helps to live less than a day’s drive away. Being familiar with the area and vacationing there with your family on other trips can help narrow your choices.

Living in a vacation area, however, can be a lot different than visiting only during peak vacation periods.

Restaurants and shops may close during the rest of the year, making it difficult to do some things. On the plus side, it can be a lot quieter and less busy, giving you a chance to have a golf course to yourself or get a table at your favorite restaurant.

What Type of Home Do You Want?

After deciding where you want to buy, pick the type of home you want.

Condominium, townhouse, duplex or a detached home come in different sizes. A house may be what you want if you want less restrictions that communal properties can have, along with more privacy and social distancing.

A house comes with more work (and more costs), such as gardening, painting and other maintenance. In a condo, an association will require a monthly fee to take care of such tasks. Internet and cable may also be included, along with insurance.

Attend a homeowners association meeting if you can, or at least walk around the neighborhood on a weekend and talk to neighbors. Try to find out how many people rent out their properties.

Make Your Offer Stand Out

Once you find a home you want to buy, work with your real estate agent to make your offer stand out. Assume that you’re in a seller’s market with plenty of other people competing for a limited number of vacation homes for sale.

Try these tactics:

• Pay entirely in cash
• Have few contingencies in the contract
• Work with the seller’s timeline
• Get preapproved for a mortgage
• Include an escalation clause, such as paying $1,000 more than the highest offer after you bid
• Write a letter about how you want to live in the home and how much you love it