By W. Todd Galde, Commerce Home Mortgage
The San Francisco Bay Area is a fantastic place to live, work and play. It is home to many major corporations, including PayPal and Apple Inc., and it is a haven for tourists who want to set their sights on the Golden Gate Bridge and the California coast. The people who live in this region love the energy and the vibe within the large cities that make up the communities, but some are seeking solace in a second vacation home. It can cost a pretty penny to live in San Francisco or the Silicon Valley — which is why many residents simply rent a small house or apartment. However, many can afford to invest in real estate and choose to purchase a vacation home in Lake Tahoe or Napa Valley. It’s a place to retreat and enjoy life’s simple pleasures while reaping the benefits of home ownership.
Buying a 2nd home in the Bay Area has become a big goal for many of our clients, said Andrew Greenwell, star of Million Dollar Listing San Francisco. “There are so many options within just a couple hours’ drive, from beachfront to ski chalet that sometimes the hardest decisions are where to buy.”
Financing a 2nd home is a bit different than financing the purchase of a primary residence. The following tips will help you prepare your finances so that you can more easily purchase that dream vacation home with those beautiful coastal views of Carmel.
Prepare a Down Payment
Second homes are not as rare as one might expect. In fact more than 20% of residential home purchases in 2014 were for secondary residences. The numbers are rising and it’s important for those considering to understand the differences behind this unique type of real estate transaction. As a mortgage on a vacation property is considered higher risk, many lenders require buyers to have a larger down payment – generally 20%. Choosing to pay cash is an alternative. There are potential options for securing cash such as taking out a home equity line of credit (HELOC) on your primary residence to finalize the purchase of your secondary residence.
TIP: In many cases, a gift from parents or family is OK to use for a down payment.
Identify the Interest Rate on Your Loan
If you plan to use your second home strictly for personal use, then you are likely going to be able to secure an interest rate that is comparable to that on your primary residence. Today mortgage rates are considered low; it is a good time to finance the purchase of a 2nd home. Please note that if the 2nd home purchase is for investment reasons, you may be locked into a higher interest rate – an increase of about .5%.
Qualifying to buy a 2nd home can be trickier than qualifying for your first home, the one you will live in, says Greenwell. “It is imperative that buyers have been pre-approved with a trusted mortgage advisor from a reputable company before meeting with a Realtor. It saves everyone time and money.”
TIP: Clearly, interest rate is important, but in today’s confusing lending environment, it is equally important that you align yourself with a knowledgeable, trusted mortgage advisor who will provide transparency of the process and fees. Choose someone who can help navigate if potential complications arise which would save you a lot of money and headache.
Calculate Your Debt-to-Income Ratio
Your current verifiable income will need to cover the future mortgage payments, insurance and taxes on your second home, along with your existing monthly obligations like primary mortgage payments or rent, property taxes, and home insurance. You are NOT allowed to use future income that will be generated as a result of renting the new home when you are applying for your mortgage. Once you have calculated general costs, you will need to calculate the debt-to-income (DTI) ratio. A healthy DTI is around 38%, although it can go higher if there are other compensating factors.
TIP: Due to the tightening of credit since the “meltdown” of 2007-2010, you should consult with a professional mortgage advisor (before submitting any offers on homes) to determine your maximum DTI and purchase price.
Determine Your Specific Tax Advantages
There are many benefits and reasons for purchasing a second home. Besides vacation, people buy secondary residences to support aging parents, board kids in college, shorten work commutes as well as for straight investment. Tax deductions can be enjoyed after the purchase. As long as you are not renting the home for more than 14 days out of the year, you can deduct the interest on the principal of your secondary residence, similar to the way that you can deduct interest on the principal of your primary residence. There are some limitations such as you are limited to deducting interest on up to $1.1M in property value combined between the 2 residences that you own. If you decide to rent your property for more than 14 days out of the year, you will be held to different tax standards. Regardless, this rent income can help boost your net worth and improve your own personal finances.
TIP: It is imperative that you find a trusted Certified Public Accountant (CPA) who will guide you through the ever-changing tax laws to make sure you maximize your deductions.
Once you have financed your 2nd home, you can now enjoy the perks. If for vacation purposes, your family and future generations can enjoy the home and its location for years to come. Whether you are located steps away from beautiful vineyards, sandy beaches, or snowy mountains, you will love having a second place to call home.
Give me a call if you would like to discuss any of the above and could possibly benefit from a free, no pressure or obligation consultation. It would be an honor to help you with your home financing needs.