Are You Ready To Purchase A Second Home Or Investment Property?

03.06.2022 | Category: Homebuying

With the interest in investment properties taking off, more and more home buyers are considering a second home to utilize as an investment property.

Investing in real estate, for many, is a sound and profitable way to build wealth and generate a passive income.

Many real estate investors purchase multiple homes and rent their properties either to long-term renters or more popularly now, short-term renters or vacationers. Since fixed mortgage rates keep mortgage payments at a stable and predictable amount, investors are able to project their profits based on market trends and earn income on both what they charge for people to rent their home and on the earned equity of their property overtime.

However, investing in real estate doesn't come without risks and there are many factors to consider before deciding to purchase a second home or investment property.

Here are 4 tips for understanding if you're ready to purchase a second home or investment property.

Be sure to do your research and get advice

As with the purchase of any home, you will want to do your research before making a decision. Factors like location, the condition of your home, and what the market demand is for rentals are all important to research before deciding to purchase a second home.

You will also want to ensure that your income is stable enough to support two mortgages should you not be able to rent out your home as expected.

Lastly, be sure to calculate the costs of living in the home such as furnishings and repairs as well as the ongoing cost of maintenance, permitting and major repairs.

Budget for the expected and the unexpected

While this might not be your first home purchase, there are still expenses that you may not consider when purchasing a second home for investment purposes. Many cities, counties and even states have permitting fees and additional taxes for investment properties whether your planning to rent out the home or sell the home for profit. You will also need to work with your tax preparer to ensure you plan for capital gains or increase in income.

In addition, the normal costs of maintaining a home also apply including utilities, maintenance, and insurance. You may be able to estimate how much these items will cost you in the long term and plan for them, however a major home repair like a new roof or plumbing may be an unexpected cost. If you have renters, you may also have to pay for their accommodations while the repairs take place or forgo income while your house sits empty waiting for repairs to be made.

Knowing when the time is right

If you have earned a large amount of equity in your first home, you may be able to pay for a large amount if not all of the cost of a second home through a cash out refinance or a home equity loan.

A cash out refinance is a popular option because it allows you to access the equity in your home at a potentially lower rate than if you took a second mortgage loan.

With a cash out refinance there are no limitations to what you can use the money for, however you should still use caution to ensure you can afford the new mortgage payment on the new larger loan.

Home equity lines of credit Is a credit line that is secured by Your home as collateral. When you take out a home equity line of credit, the maximum amount you can charge is based on the amount of equity in your home.

With interest rates still historically low, many homeowners are finding the option for using the existing equity in their primary residence attractive for the purchase of a second home. The same criteria apply for homeowners only lenders typically are more stringent when homeowners looking to buy second property are going through the loan approval process.

Be prepared to meet more rigorous lending standards and for lenders to potentially ask for larger down payments or charge higher interest rates. Your creditworthiness will still need to be excellent and your debt to income ratio low in order to qualify for a home on a second property. The process may take more time and require additional income and asset verification, potentially delaying your ability to rent the investment property sooner. Be sure to plan for these delays and have enough saved should you not earn an income on your property right away.

Understand how you plan to use the second home

Whether you plan to use your second home as a personal second residence, an  investment property, or a rental, you will need to disclose this information to the mortgage lender you choose to work with.

By law, underwriters follow the guidelines of Fannie Mae and Freddie Mac to determine whether or not you are in a financial place to assume the risk of a second home.

Before you can classify a vacation home, for example, as a second home for mortgage purposes you have to meet certain lender requirements. You must live in the home for at least part of the year and use it for personal enjoyment for at least half the year.

If you plan to offer short-term rental opportunities on your second home, mortgage guidelines stipulate that the property cannot be under control of a property management company. This can be tricky to understand so be sure to work with a real estate expert to understand exactly what constitutes as a property management company in your city, county or state. Popular short-term rental apps may be considered property management companies in some cases and could disqualify you from listing your home as a personal vacation property.

If the purchase of another home is to renovate and resell, or rent to tenants, you may be expected to pay a higher down payment and a slightly higher interest rate than if the property is considered a second residence. This is because lenders consider investment properties to be riskier and face a higher chance of renters unable to make their payments, leading to landlords skipping mortgage payments. If you plan to use your second property as a rental, you may be asked to produce a rent schedule and/or lease to show that you are earning an income through your rental property.

Another note to keep in mind is that VA and FHA loans cannot be used to purchase second properties.  In addition, these loans are designed to help prospective homeowners meet lending criteria that can be challenging for first-time homeowners or active duty service members to meet.

If you’re ready to purchase a second home or investment property, be sure you’re preapproved with a reputable lender like Mutual of Omaha mortgage who can help ensure the process is smooth and you’re well informed every step of the way. Once you’re preapproved, work with an experienced real estate professional to help you find the right property for you and you’ll be enjoying your next home in no time.