Debt-to-Income Ratio for a Second Home

If you’re thinking about taking out a mortgage for an additional property, whether through a HELOC, second mortgage or other second home financing, lenders in the United States and Canada will look closely at your debt-to-income ratio for a second home. 

In this guide, we’ll look closer at debt-to-income (DTI) ratios and lender requirements in the context of buying a second home. 

What is a Debt-to-Income Ratio and Why is it Important?

Your debt-to-income ratio is a measure of your gross monthly income that goes to paying your monthly debt (total monthly debt payments divided by gross monthly income).

The higher your DTI ratio is, the more income you have committed to your monthly debts. A high DTI ratio means you’re a higher risk of default and may not be able to take on another loan. A low DTI ratio means you may be able to take on more debt and pay everything on time.

When you’re shopping around for the right lender to buy a second home, remember this – major banks typically required lower debt-to-income ratios. They have strict guidelines because they have only a few programs to fit borrowers into and they don’t have much leeway. On the other end of the spectrum, private lenders, take larger risks and allow higher DTI ratios in exchange for higher interest rates and fees. 

What is the Maximum Debt-to-Income Ratio for a Second Home?

On the low end, lenders prefer a maximum 36% debt-to-income ratio, but some lenders will go as high as 43%. These are just guidelines set by the government agencies investing or backing the loans. Each lender can make its own decision on a case-by-case basis, allowing them to accept higher DTI ratios if borrowers have compensating factors, such as a high credit score or a large amount of savings (reserves) on hand.

In the United States, many lenders mandate a maximum 43% debt ratio because that’s the highest ratio allowed for a loan to be considered a Qualified Mortgage (QM). A QM is a loan the lender did its due diligence on to ensure you could easily afford it and won’t be subject to financial distress. 

In Canada, some lenders can accept DTI ratios up to 44%, which is the highest debt ratio allowed for CMHC’s Homeowner Mortgage Loan Insurance. This insurance is what allows borrowers to secure financing with less than a 20% down payment.

Whether you’re in the US or Canada, the debt-to-income ratio requirements will vary based on your other qualifying factors including the amount of money you put down on the home and your credit score. For example, Fannie Mae allows a DTI ratio up to 45% if you have at least a 660 credit score and 25% or higher for a down payment. In short, the better your other factors are, the higher the DTI ratio a lender can accept.

How to Calculate Debt-to-Income Ratio For a Second home

To calculate your DTI ratio, use the following formula: total monthly debt payments / gross monthly income = DTI ratio.

Now let’s look at a hypothetical example. Susan is interested in buying a beach house in Palm Beach, Florida but would like to better understand what she can afford. Here is a snapshot of her finances:

• Monthly employment income (before taxes): $8,000
• Monthly mortgage payment on primary residence: $1,300
• Other monthly housing expenses on primary residence (property taxes/insurance): $200
• Monthly car loan payment: $250
• Savings for down payment: $105,000

Using the above figures, Susan currently has a debt to income ratio of 21.875% ($1,300 + $200 + $250 / $8,000). Now let’s see what she can afford using the debt-to-income ratio calculator below.

Be sure to explore the debt-to-income ratio calculator yourself to understand what you can afford in a second home. Simply input the relevant amounts to determine the maximum amount you can afford based on your debt to income ratio.

Assuming an interest rate of 3.0% on a 30 year mortgage, Susan can afford a further monthly mortgage payment of up to $1,690, which means she can afford a second home mortgage in the amount of $400,850.  With a down payment of $105,000, she can afford a vacation home worth approximately $505,000. But now let’s assume that another home has recently come on the market for $575,000, which is in excess of her limit. Yet, by factoring in her anticipated rental income, she can afford it. Here’s how. Let’s assume that she can rent out her vacation home part time through Airbnb while it’s not in use for $1,000/month and that her bank is willing to give her credit for up to 70% of the fair market rents. Using the calculator, she can now afford a second home mortgage of up to $472,244 and a vacation home with a purchase price of approximately $577,000 (after factoring in the down payment). 

Note that mortgages for second homes will typically be associated with stricter lending criteria and higher interest rates than primary residences. For an investment property, such as a vacation rental, you can expect interest rates to be even higher and even higher down payment requirements.

5 Ways to Improve Your Debt-to-Income Ratio

Fortunately, your debt-to-income ratio can change. You are in control of it and can help your DTI ratio with these tips.

• Pay your revolving debt (credit card balances) down as fast as you can. Zero balances are best, but even lowering your balance slightly can reduce your DTI ratio.
• Cut back on expenses. Think of the bills reported to the credit bureaus and see what you can pay off or cut out of your budget.
• Don’t open new credit accounts. No matter how attractive an account looks or how many rewards a new account offers, don’t open a new account. Think of your overall goals of buying a second home and refrain from opening new credit.
• Refinance your loans. If you have high-interest loans and credit cards, see what you can do to consolidate or refinance them. If you have good credit, you may qualify for a 0% annual percentage rate (APR) balance transfer credit card or an installment loan with a low APR.
• Find ways to supplement your income. Rental income, starting a side gig, or even asking for a raise at your job can increase your income and lower your debt-to-income ratio.

Other Second Home Lending Criteria

The debt-to-income ratio for a second home is one of the largest factors lenders consider, but they look at other factors too including:

• Credit scores of at least 640 – Most lenders allow a score of 640, but you’ll get the best terms and lowest rates with a credit score of 700+.
• Down payment of at least 20% – Second homes pose a higher risk of default so most lenders require at least a 20% down payment, sometimes more.
• Rental income – If you’ll rent the home while its not in use, you may be able to get credit for the projected rental income in your qualifying factors to help you get approved.
• Stable income and employment – Lenders need to know you can afford another mortgage. They’ll look closely at your employment and income history to ensure it’s consistent and stable.
• No recent bankruptcies or foreclosures – Lenders look at your past insolvency history and may require a certain amount of time between a bankruptcy or foreclosure before you can apply for a mortgage on a second home.

Final Thoughts – Debt-to-Income Ratio for a Second Home

Next to your credit score, your debt-to-income ratio for a second home is the most important factor. Lenders use your DTI ratio to ensure you can afford another mortgage. Since a second home isn’t your primary residence, there may be less incentive to keep up with the payments if you’re in financial trouble. You won’t lose a place to live, so lenders realize that you may not work as hard to keep it.

Lenders make up for this risk by ensuring you have a low DTI ratio, good credit score and a healthy down payment. Assess your qualifying factors before applying for a mortgage on a second home to ensure you qualify.