It is important to know exactly what you can do and what the loan requirements are prior to pursuing any property. The guidelines for a primary residence purchase are completely different than the guidelines for an investment property, vacation home or second residence. Some of the changes may impact the interest rate or the amount of private mortgage insurance (PMI) required. Other guidelines can impact your approval and whether you can move forward with the purchase.
Vacation properties can be an effective long-term way to enjoy a destination you have come to love, but only if you fit the loan guidelines. Here are the four main loan requirements for a vacation or second home.
Increased Down Payment.In recent years there has been a growing number of primary residence purchase options. Between conventional & FHA alone there are several programs that require just 3-3.5% down payment. Additionally, credit score guidelines have been reduced as well as lower debt to income standards on some programs. While there have been significant changes on primary residence loans the non-owner-occupied side has remained the same. Getting approved for a second residence or a vacation home still has a strict set of guidelines. The first hurdle is the increased down payment requirement. You may be able to find a lender that can do 10% down but the industry norm is at least 20%. Vacation homes are considered a higher risk factor for banks and require a large chunk of equity as a minimum starting point. This money must be seasoned in an existing bank account for at least 60 days and if any portion of the money is borrowed the repayment will be counted as debt.
Reserve Requirements.It is not enough to have all the down payment funds available. Because of the risk factor associated with second homes lenders want as much protection as possible. Depending on the specific property and the credit profile the lender will ask for anywhere from one month to up to six months in reserves. This means that they need to match the total monthly payment in assets for the months required. You can have all the down payment and closing cost money but without reserves your loan will be rejected.
Higher Credit Standards.A vacation or second home loan approval requires an almost near perfect application. Your credit profile needs to be excellent in all areas to gain approval. A minimum starting point for your credit score should be at least 680, with some lenders 700 and higher. Additionally, the last twelve months of mortgage history needs to be perfect with no 30 day, or more, mortgage lates. You also cannot have any previous bankruptcies, short sales or foreclosures for a minimum of three years, depending on the specific program.
Low Debt to Income.The final piece of the approval puzzle is the debt to income ratio. Lenders look at all the minimum monthly payments on the credit report in addition to the proposed housing payment and divide that by the gross monthly income. This number typically needs to be under 50% for a primary residence but for a vacation home should be under 45%, and in some cases lower. This can be difficult for a vacation home that doesn’t generate full time rental income. If the property does, it will be considered an investment property which has a different set of underwriting guidelines.
A vacation property or second home can be a great long-term investment for you and your family for years. Getting approved may be difficult but is far from impossible.