Mortgage Options Available To Buyers of Second Homes

Columnist Jane Hodges on the variety of financing options consumers can employ to purchase a vacation house.
By: Jane Hodges: The Wall Street Journal Online
Question: My wife and I want to buy a second home in Florida. We'd use it initially as a vacation home, but might want to relocate there once our son finishes high school. We're not sure how much house we can afford. Can you tell us how securing a mortgage for a vacation property differs from getting a home loan on a primary residence?

- Bobby Hickman, Atlanta

Bobby: In many ways, borrowing to buy a vacation home doesn't differ much from taking out a loan to purchase a primary residence.

"You can do pretty much anything to borrow for a second home that you can to buy a first home," says Dave Craig, a mortgage loan officer at First Horizon Home Loans Corp. in Seattle.

Many second-home buyers pursue a separate, additional mortgage for their vacation property. In the past, a down payment of at least 5% would have been required. These days, says Steven Schneider, a partner with Abacus Lending Group Inc. in Miami and president of the Florida Association of Mortgage Brokers Inc., there are more flexible products available, including interest-only loans (in which you make smaller, interest-only payments for a set period of years, and then pay back both principal and interest in bigger payments) and "pay option" adjustable-rate mortgages (ARMs), where you decide which of a variety of payment forms to make each month. Pay options can include an amount based on a low teaser interest rate (say, 1.5%) available for a short period of the loan, an indexed interest rate that tracks a benchmark rate such as one-year Treasury bills), or fixed rates on a 15-year or 30-year loan, or others.

If home values continue to rise in the state (as they generally have been), loans like interest-only and pay-option ARMs may be good options for second-home buyers, Mr. Schneider says. However, if housing prices come down, or if you always make the lowest payments permissible, it's possible to end up owing more on a house than you bought it for under many pay-option ARM formats. Interest-only borrowers, like buyers of primary homes, sometimes run into trouble when they have to start paying the higher combined mortgage payments for both principal and interest.

If you plan to rent the home out more than 10% of the time, you may be charged a slightly larger loan-origination fee, up to one-and-a-half points higher, to get the same rate a nonrenting owner would, Mr. Craig says. The reason for this, he notes, is that lenders consider loans for owner-occupied property (meaning you use the property the bulk of the time) to be less risky than those on rentals.

Many borrowers finance their second home by tapping the home equity in their primary home. You could consider a "cash-out refinance" of your primary home - a mortgage on your main home that is based on how much your home has appreciated in value since purchase. A cash-out refinancing is more prudent than taking out a home-equity line of credit or a second mortgage on your primary home, as interest rates have been rising more significantly on both home-equity loans and second mortgages, Mr. Craig says. Current rates for home-equity and second mortgage loans can be found at www.bankrate.com.

If you are going to sell your current home when your son finishes school, a traditional adjustable-rate mortgage (ARM) might be a good choice. You could take out a five-year or seven-year ARM with a low initial interest rate. The sale of your primary residence may give you a large influx of cash to make the payments when the rates on your vacation home's mortgage adjust upward. The profit from the sale of your house could allow you to either pay off the loan or pursue other financing options.

- Ms. Hodges is a free-lance writer in Seattle. She answers questions about managing second homes in Owner's Manual. Please send your questions to RealEstateJournal@wsj.com.

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