A borrower looking to finance a vacation home has several options. Among them are a conventional mortgage, home equity loan, home equity line of credit (HELOC), or cash-out refinancing loan.
Before choosing a way to finance a vacation home, consider the lender’s requirements for credit scores and down payments as well as other factors that’ll determine whether you qualify for financing and how much your interest rate will be.
Buying a vacation home can be a great way to create lasting memories with your family and friends. However, financing a vacation home purchase requires careful planning and consideration. In this comprehensive guide, I will walk you through everything you need to know about getting loans for vacation homes.
Overview of Loan Options
There are several ways to finance the purchase of a vacation home:
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Conventional Mortgage – This is a standard home loan from a private lender like a bank or credit union You’ll need a down payment of at least 10-20%
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Home Equity Loan – If you have equity built up in your primary residence, you can take out a home equity loan against it to finance a vacation home. This option doesn’t require any down payment.
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Home Equity Line of Credit (HELOC) – A HELOC works similarly to a home equity loan but is structured as a revolving line of credit. You only pay interest on the amount you borrow
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Cash-Out Refinance – You can refinance your primary mortgage for more than you currently owe and use the difference to buy a vacation home in cash.
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Family Financing – If you have a family member with the means, they may agree to finance the vacation home purchase for you. This avoids bank qualifying.
Loan Qualification Criteria
Qualifying for a vacation home loan is typically more rigorous than qualifying for a primary residence loan. Here are some key criteria lenders look for:
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Down Payment – You’ll likely need at least 10-20% down on a vacation home. Conventional mortgages usually require 20%.
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Credit Score – Aim for a credit score of at least 680 or higher. Under 620 will be tough to get approved.
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Debt-to-Income Ratio – Lenders prefer this to be under 45% for vacation home loans compared to 50% for primary homes.
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Reserves – Having 2-6 months of mortgage payments in reserves is recommended. More reserves means better approval odds.
Meeting these criteria ensures you can comfortably afford the vacation home long-term and gives lenders confidence in your ability to repay.
The Loan Process Step-By-Step
If you’re ready to move forward, here is an overview of the loan process:
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Get pre-qualified – Talk to a lender and get pre-qualified so you know your budget and financing options before house hunting.
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Find the home – Once pre-qualified, start searching for vacation homes within your affordable price range.
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Make an offer – When you find the perfect vacation home, make an offer contingent on securing financing.
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Complete loan application – Your lender will guide you through completing a detailed loan application and gathering required documents.
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Home appraisal – The lender will send out an appraiser to evaluate the home’s market value and condition.
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Underwriting – Your file will go through underwriting, where the lender verifies all details before final approval.
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Closing – Finally, you’ll sign all the closing documents and the home is yours!
Working with a trusted lender who specializes in vacation home loans simplifies this process. Be sure to ask questions along the way so you fully understand each step.
Tips for Securing Financing
Here are some top tips for improving your odds of vacation home loan approval:
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Maintain excellent credit – Any credit scores above 740 will help ensure you get the best rates/terms.
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Lower your debt-to-income ratio – Pay down existing debts so you have more free monthly income.
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Make a larger down payment – Putting 20% or more down shows lenders you’re financially committed.
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Have ample cash reserves – Lenders want to see you have reserves to handle unexpected costs.
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Use a co-signer – Adding a co-signer with strong credit can help you qualify if needed.
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Prepay expenses – Offering to prepay HOA fees, taxes, and insurance upfront looks attractive.
Following these tips sets you up for success in securing a vacation home loan.
Shopping For The Best Loan Rates
As you evaluate loan options, be sure to shop around and compare rates across multiple lenders:
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National lenders – Large banks and online lenders can offer very low rates but less personalized service.
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Local lenders – Community banks and credit unions may have slightly higher rates but provide guidance tailored to vacation home financing.
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Mortgage brokers – Brokers can shop your loan around on your behalf to find you competitive rates.
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Get pre-qualified – Having lenders run your credit and provide pre-qualification letters allows accurate rate comparisons.
The lowest rate offer isn’t necessarily the best if it comes with hidden fees or strict requirements. Weigh the overall value when choosing a loan.
Critical Factors That Impact Loan Costs
Many factors determine your final loan costs. Being aware of these can help you make informed choices:
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Interest rate – Lower interest rates reduce your all-in cost over the life of the loan. Shop aggressively for the lowest rate.
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Loan term – Shorter loan terms (e.g 15 years) have higher monthly payments but save substantially on interest.
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Loan type – Fixed-rate loans have stable payments while ARMs carry future rate risk. Weigh the pros and cons of each.
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Upfront costs – Look at origination fees, application fees, and points to compare true loan costs.
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Prepayment penalties – Some lenders charge fees if you pay off your loan early. Avoid these if possible.
Running the numbers on loan cost scenarios prevents surprises and helps identify the most cost-effective financing.
Special Considerations for Investment Vacation Homes
If you plan to rent out your vacation home for a significant portion of the year, lenders will view it as an investment property. Here’s what to keep in mind:
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Higher down payment – Investment vacation homes typically require 25-30% down.
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Higher rates/fees – Investment loan rates are 0.5 – 1% higher than primary home loan rates.
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Restrictions – Some lenders limit the number of investment homes or won’t lend in certain markets.
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Rental income – A portion of projected rents can supplement your income for qualification purposes.
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Tax implications – Rental income and expenses impact your taxes. Consult an accountant to maximize tax benefits.
Work closely with your lender to ensure your loan application accurately reflects the investment nature of the vacation home.
Alternatives If You Can’t Qualify for a Loan
If you don’t qualify for a traditional vacation home loan, alternatives to consider include:
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Partnering with co-buyers – Share purchase and ownership costs by buying with family or friends.
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Seller financing – Some sellers may provide owner financing themselves with only 10-20% down.
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Paying all cash – Using your existing savings or assets allows you to avoid financing.
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Using a home equity loan – Tap equity you have in your current home if you can’t qualify for a new loan.
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Trying again later – Improving your financial profile can help you qualify down the road.
With perseverance and a prudent plan, your dream vacation home can absolutely become a reality. Don’t get discouraged if it takes some time.
The Takeaway
Buying a vacation home is a major financial move but achievable if you plan wisely. Seek out the most qualified loan for your situation, understand all costs, and work with trusted professionals. Patience and diligence in securing financing will pay off enormously once you start making vacation memories year after year. Wishing you the best of luck!
Financial Requirements
Financial requirements that a mortgage borrower normally must meet when buying a vacation home include:
- Adequate credit score: For most mortgages, a lender requires a FICO score of at least 620 when a borrower is buying a vacation home.
- Acceptable debt-to-income ratio: The debt-to-income ratio (DTI) measures how much someone’s monthly debt obligations are vs. how much their gross income is each month. In general, a borrower needs a DTI of 45% or below to qualify for a mortgage on a vacation home.
- Sufficient assets: A lender typically adds up a borrower’s assets, such as savings, checking, and investment accounts, to gauge whether they’d have enough money available to cover the loan in case of financial troubles (such as losing a job).
A borrower taking out a conventional mortgage to finance a vacation home might need a credit score of at least 620 and a down payment of at least 10%.
Key Documents
Among the documents you’ll likely need to supply when you’re taking out a mortgage for a vacation home are:
- Proof of income and employment: For a borrower with a traditional job, a lender typically requires recent pay stubs and two years’ worth of W-2 forms as proof of income and employment. For a self-employed borrower, a lender might want to see two years’ worth of personal tax returns, two years’ worth of business tax returns, a year-to-date profit-and-loss statement, and a business balance sheet. In addition, a self-employed person may need to provide letters from current clients, a signed statement from their CPA, a business license, and proof of business insurance.
- Financial statements: Generally, a lender will request that a loan applicant provide statements from their bank and investment accounts.
- List of monthly debts: This may include credit card bills, home insurance premiums, and loan payments (such as those for car loans, student loans, and personal loans).
- Recent mortgage statements: If you own a primary residence, the lender for a vacation home purchase likely will want to see recent mortgage statements for that residence.