Refinancing a Second Home in Today's Mortgage Market
If it's been a while since you took out a loan on your second home, you will probably find that refinancing it today is a whole new ball game. Mortgage giants Fannie Mae and Freddie Mac write the guidelines for 90% of conventional mortgages, and they've changed the rules.
Refinancing your primary residence isn't the only way you can save money. A lower interest rate on your second home could pay for home improvements, new furniture, repairs to the boat and more family barbecues. If you qualified for a mortgage refinance on your primary home in the last year or so, chances are you can refinance your second home as well.
You'll Need Substantial Equity
You can buy a second home with 10% down and get mortgage insurance, according to the Mortgage Guaranty Insurance Corporation. However, you will not be able to refinance a second home if you have less than 20% equity. This is because most, perhaps all, mortgage insurers do not cover second home refinance transactions anymore.
A Second Home and Your Debt-to-Income
If your mortgage on your primary residence takes up 31% of your monthly income, you'll probably qualify, but your second home can't consume another 31%. Your second home expense is treated like your car, credit card and other monthly payments -- as part of your total debt-to-income ratio. When financing a primary residence, mortgage lenders may allow total debt-to-income ratios of up to 41%. A lender can feel fairly confident that the first 31% of your monthly income will go toward the mortgage, and it's the other debts that might go unpaid if your income drops. However, loans on second homes are those "other debts." So expect more restrictions on acceptable debt-to-income-ratios when refinancing a second home -- expect up to about 40% for well-qualified borrowers and less for others.
Vacation Homes versus Investment Properties
Both second homes and rental properties are not occupied full-time by you, the owner. However, it's considerably more expensive and difficult to finance a rental home than a vacation home. (For instance, at an 80% loan-to-value ratio, a mortgage on an investment property costs 3.75% more to originate than one on a second home.) This is because, when refinancing an investment property, the property's income is used to help you qualify for the mortgage. If something happens to that income, you may not be able to afford the loan payments.
Those refinancing a vacation home, on the other hand, have to prove they have enough income to comfortably make their payments without the benefit of rental income from the property. Additionally, people may be considerably less attached to their rental across town than they are to their vacation house that the family celebrates July 4th in every year. As such, borrowers are statistically less likely to default on vacation homes.
What Makes a Property a Vacation Home?
So, you're thinking, I have a rental property and I don't need the income from that property to qualify for a mortgage. Could I just call it a vacation place and save almost four points on my refinance? Probably not. Once the lender looks at your taxes, and assuming the rental is shown on a Schedule E, that option is dead. Ditto if the lender's appraiser goes out to see the property and a rental agent lets him or her in. Fannie Mae lists the requirements for your second home:
- The property must be reasonably far away from your primary residence, because no one vacations down the street.
- You have to occupy it for some part of the year.
- It must be a 1-unit place, because duplexes, triplexes and fourplexes are generally rented out.
- It must be suitable for year-round occupancy.
- You must have exclusive control over the property -- no management companies and no time-share arrangements.
Special Considerations if You Have Multiple Financed Properties
If you are financing a second home and own up to four financed properties, standard underwriting guidelines apply. If you have five to 10 financed properties, you can only refinance your second home to a maximum of 70% of its value, and you will need a minimum credit score of 720. In addition, you can have no history of bankruptcy or foreclosure within the last seven years, no mortgage delinquencies within the last 12 months and you need six months of reserves (principal, interest, taxes, and insurance) for each financed property you own, plus two months' reserves for the second home.
Second home refinancing, if you qualify, can save you as much as refinancing your primary residence. Since there are no second home surcharges, you can get the lowest mortgage rates available for your financial situation -- as good as what you can get for your primary residence.
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Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.