Finding the right vacation home in a location of choice, with all desired amenities, that fits the budget, with a proper timeline established to maximize the investment, whose offer has been accepted by the seller is cause for great celebration.
The new owner is practically over the finish line, ready for some much-needed downtime.
There’s just one more bridge to cross before landing in paradise: Paying for it all.
Financing the Fantasy
Vacation home financing can come from multiple sources, each with various implications.
Some purchasers use existing equity, a concept discussed in a prior post in this series. Equity can be used to cover the entire purchase price of a vacation home, via a cash-out refinance of a primary property, a home equity loan, or a home equity line of credit on an existing home.
Other buyers use conventional loans.
Another option is to blend the two approaches: Use the primary residence’s equity as a down payment and then borrow the monthly installments.
There is one current advantages to the loan v. mortgage tactic: In today’s active market, it can enable the purchase price to transfer to the sellers’ pocket more quickly. As sellers evaluate a slew of offers on their listed homes, this may be an advantage to a buyer who has his or her heart set on a specific dwelling.
But those purchasers employing the technique also bear an associated risk: They’ve got to have the financial wherewithal to make two loan payments per month.
A more common approach to vacation home purchasing is the second mortgage.
Because these financial instruments represent greater risk to the lender, they also require a more stringent set of evaluators before qualifying.
Banks theorize, perhaps rightly so, that if a homeowner hits the financial skids, the payments on an additional property are likely to slow (or cease) sooner than those on a primary residence.
Common protectants that banks and financial institutions use are:
- A two-month reserve of cash (at least)
- A down payment of at least 10 percent of the home’s value (a non-negotiable floor)
- Requirements for a higher credit score from the buyer
- Higher interest rates applied to the loan
- Prescribed credit score and debt-to-income ratios
- Occupancy parameters
That last protection may seem counterintuitive — what owner wouldn’t want to spend time in his or her own lakeside cabin or theme park–adjacent condo at least part of the time?
But the bank wants to ensure that the vacation home is, in fact, a home for its owner. If it is rented year-round, with no deedholder’s presence, the structure becomes an investment property with a host of different mortgage requirements.
In addition, owners’ time on property, in the bank’s eyes, can ensure that routine maintenance remains current, local ordinances are being upheld, and any other personal issues (complaints from neighbors, theft from tenants) don’t become long-term detriments.
In addition, most financial institutions require that the second mortgages they issue are to buyers obtaining a home that is:
- Suitable for year-round use
- Owned solely by the buyer
- A one-home unit (not a duplex, triplex, or four-plex)
- Not operated as part of a timeshare structure
- Not operated by a property management company that controls occupancy
You couldn’t finance a property using a second home mortgage and then rent it out full time. You yourself need to stay there for part of the year.
If all this sounds daunting — as if owning a vacation home is so onerous, there’s no financial way its purchaser can even enjoy the thing — take heart. Uncle Sam offers a few incentives in the form of tax breaks, that can augment the experience of owing a getaway nook.
Tax deductions are possible (your millage may vary) in the following ways:
- Deduction of state and local property taxes ($10,000 per return or $5,000 each for married couples who file separately).
- Mortgage, insurance, and property tax breaks on rental property income from tenants who occupy the home for more than 14 days each year.
Crossing the Finish Line
With all the due diligence mentioned above, the transaction portion of obtaining a vacation home unfolds in much the same way as its permanent residence counterpart. The financial and legal vetting is completed, all inspections are done, applications are made and approved (fingers crossed), all parties gather for closing, and the deal is sealed.
It’s time to cross that new threshold, enjoy a new panoramic view, and perhaps toast the good fortune of owing a vacation home.
About Penn Community Bank
With more than $2.5 billion in assets and over 300 team members, we are the largest mutual bank in eastern Pennsylvania. Our size and reach make us uniquely qualified to help our customers reach their own “Here We Grow” moments for their families, their businesses, and their communities.
We’re here to partner with community organizations leading the charge for positive momentum. Our growth mission is to deliver solutions that genuinely serve the best interests of our individual and commercial customers in ways they cannot possibly experience at more traditional financial institutions. As a bank powered by good values, we are a catalyst for good with the flexibility, responsiveness, and experience to guide next-level growth for everyone we serve.