Best Ways to Fund Your Vacation Home

We've all thought about buying that second home, whether it's a quaint log cabin in the woods or a scenic bungalow down by the coast. Aside from the obvious financial hurdles, it's important to understand the pros and cons of different financing methods for your new home. In this post, we'll cover some of the best ways to make your second home purchase a reality.

 

Best Ways to Finance a Second Home

Most investors agree that the best way to finance another home are through the use of the existing home equity in your primary residence. Most people access their home equity through the use of second mortgage products like HELOCs, reverse mortgages and even cash-out refinances when the rate environment warrants it. 

Home Equity Loans allow you to borrow a lump sum against the equity you've accumulated in your house. These are installment loans which are repaid with monthly payments over time, similar to your primary mortgage. Home equity loans typically consist of a fixed interest rate and make it easy to access large amounts of your net worth for one big purchase.

Home Equity Lines of Credit (HELOC) are revolving credit lines with variable rates that can be drawn and repaid as needed, much like your credit card, making them a flexible source of funding. These are one of the most popular ways to fund a down payment on a home, but it's generally not a good idea to max out your usage on these products. Keep in mind that the use of revolving credit drives up your utilization ratio and will likely lead to a drop in your credit score.

Reverse Mortgages are an option for borrowers 62 years of age or older. These loans enable you to borrow money from your home without requiring repayment until you leave your property. This makes it easy for older Americans to buy a second home while preserving their savings for use in retirement. Remember that the interest on these loans will continue to grow while the loan remains outstanding, so make sure you plan accordingly when considering this product.

Cash-Out Refinancings allows you to refinance your mortgage for more than you owe, and cash out on the difference as a lump sum. They're especially attractive if current rates are lower than the rate you're paying on your existing home loan. The rates on primary mortgages are also generally cheaper than comparable home equity rates, so you'll be able to save relative to taking out a new home equity loan. It's important to understand that your monthly payments will increase as a result of your new larger balance from the cash-out.

Loan Assumptions are when borrowers take over on the mortgage payments from the sellers of the property. These are an excellent choice if the seller happens to have an existing FHA or VA loan won their house, but typically aren't an option if they're carrying a conventional mortgage. You'll generally only have this option with government-sponsored mortgages, so check with the borrower and their lender to see whether this is an option. The obvious downside is that you'll need some luck to find a home with an owner who already has an FHA or VA loan, and not every lender will be willing to accomodate these arrangements.  

401(k) Loans receive mixed reviews from both borrowers and financial advisors. On the one hand, they're an excellent way to borrow funds "interest-free" from yourself, and repay those funds over time. However you'll lose out on any potential investment earnings that you could've gained from leaving the money untouched in your 401(k) account, which could've compounded over time. The required repayment periods on these are also shorter than other loans, which will result in a higher monthly payment. Be prepared to deal with any tax penalties that will be assessed if you a) fail to repay the funds, or b) lose your job while the loan is outstanding.

 

In any case, borrowers should keep in mind that HELOCs, home equity loans, and any loans taken out against your residence could jeopardize your ownership of your primary home if you end up defaulting. This may cause you to lose both your residence as well as your investment if the lender(s) initiate foreclosure proceedings. Make sure you treat these loans with the same level of consideration as you would for your primary mortgage. 

When considering whether you can afford a second home, understand that you'll need to meet your new monthly payments in tandem with any other debts you might have outstanding. The last thing you want is to lose both homes because you couldn't afford the new combined payments.