If you’re in the market for a second home, you may find that it’s more difficult to secure financing. Lenders have stricter requirements including a much larger minimum down payment for a second home. This is because lending money for a home that isn’t your primary residence is risky business. You have much less to lose in a second home compared to your primary residence. In fact, most lenders in the US and Canada require at least a 20% down payment, if not more on a second home.
The Difference Between a Second Home and an Investment Property
Lenders must know what you’re doing with a second home since it can have many roles in your life. Any property that isn’t your primary residence could be a vacation home, part-time residence, or an investment property.
A “second home” is a property you use for your personal use. You may use it as a vacation home, visiting only a couple of times a year or as a part-time residence if you live in multiple areas, such as spending the winters in Florida and the summers in Chicago. You might even buy a second home that will eventually become your primary residence.
An “investment property” is a property you rent out to others. Lenders take a vested interest in this because investment properties have a much higher risk. You are more likely to default on the loan if your renter defaults and abandon the property than you would a property you use yourself.
So, while the guidelines in this article generally apply to second homes, lenders may have heightened down payment requirements for investment properties. Keep in mind, if you buy a “second home” in the United States, it must be at least 50 miles away from your primary residence for you to take advantage of the more lenient guidelines for second homes versus investment homes.
Minimum Down Payment for Second Home
Any time you’re buying something other than a primary residence, you’ll need a larger down payment. Lenders require more “skin in the game” to offset the risk of default that second homes and investment properties have.
Since FHA loans aren’t an option for anything except primary residences in the United States, you’ll need conventional financing or a portfolio loan from a private lender. Either way, lenders typically require between 20% – 25% down on a second home to make it less risky for them. If you use the property as an investment property, they may require an even higher down payment.
In Canada, you may still get away with a down payment lower than 20%, but you’ll pay mortgage insurance on the loan until you owe less than 80% of the home’s value to make up for the risk. If you have a 20% down payment, you’ll increase your chances of securing conventional financing and you’ll avoid mortgage insurance.
How Does a Higher Down Payment Impact Your Mortgage?
With a higher down payment, this lowers the risk profile from a lender’s perspective since you have more to lose should you default on your mortgage. As a result, you will likely have a larger pool of lenders willing to loan you the money at more competitive rates. This also means that you will need to borrow less money, resulting in lower interest payments over the life of the mortgage and lower monthly payments. Alternatively, you could stick with the same monthly payments that you would otherwise be making with a lower down payment and pay-off your mortgage quicker.
For the purposes of illustration, let’s look at some examples using the mortgage calculator below. Let’s assume you’re interested in buying a condo on the beach for $300,000. A bank is willing to provide you with a 30 year mortgage at an interest rate of 3.0% annually.
Note: for more detailed calculations, including a complete amortization schedule, try our Vacation Home Mortgage Calculator.
Scenario 1: Lower Monthly Payments
Using down payment scenarios of 10%, 20% and 30%, the table below shows the impact on your monthly payment and total interest.
|10% Down Scenario||20% Down Scenario||30% Down Scenario|
So if you want to save over $250 a month in mortgage payments and more than $30,000 in interest, putting down 30% vs 10% will be the best option.
Scenario 2: Shortened Mortgage Period
If you’re hoping to pay off your mortgage as quickly as possible, then a higher down payment and shorter mortgage period may be a better option. Using the above scenario, let’s say you’re deciding whether to put 20% or 30% down. As illustrated in the above table, your monthly mortgage payment with 20% down equals $1,011.85. If instead you decide to put 30% down, then by making roughly the same monthly payments (~$995.84) you would be done paying your mortgage in 25 years. You’ve now shaved off five years of your mortgage and saved more than $35,500 ($124,265.89-$88,753.13) in aggregate interest payments.
As you can see, under either scenario you end up paying less interest because you’re borrowing less money.
Three Ways to Use Equity from Primary Residence to Come Up with Down Payment
In the US, you can typically borrow up to 80% of the home’s value, but this includes the amount of your first mortgage too. You can usually take out the difference and use it to meet the minimum down payment for a second home.
In Canada, you can borrow up to 65% of the home’s value, using the difference between the loan amount and your first mortgage as your down payment.
So how do you tap into your home’s equity to buy a second home? Here are three simple ways:
Home Equity Line of Credit
A home equity line of credit is a second mortgage on your property with a variable interest rate. It works like a credit card, where you can draw funds, using them how you need and make interest payments only on the amount you withdrew.
Your interest rate may change monthly and you must make principal and interest payments to repay the amount you borrowed. In the US, repayment of the principal begins after ten years whereas most HELOCs in Canada have an indefinite period.
Home Equity Loan (Second Mortgage)
A home equity loan is a second mortgage with a fixed interest rate. You make principal and interest payments right away and receive the full amount up front. At closing, the lender takes second position on your existing mortgage. You can’t withdraw funds repeatedly like you can with a HELOC, but you have the reassurance of a fixed rate mortgage.
A cash-out refinance is a refinance of your first mortgage. You pay off your first mortgage and receive the difference between the new loan amount and the payoff in cash to use as your down payment. Since it’s a first mortgage, it’s less risky for lenders and you may secure a lower interest rate.
Other Qualifying Criteria to Buy a Second Home
To qualify for a loan for a second home, you must generally meet the following requirements:
- Minimum 640 credit score, but a credit score over 700 increases your chances of approval and lowers your interest rate
- Maximum debt-to-income ratio of 43%, which includes the new mortgage and any existing debts
- Strong history of stable income and employment for at least the last two years
- No recent public records, such as a foreclosure or bankruptcy
- Proof you can balance both mortgages without relying on uncertain sources of outside income
The minimum down payment for a second home and other requirements are stricter than when you bought your primary residence. This is due to the increased risk profile of a second home. Before securing financing, you’ll need to differentiate between how you’ll use the home. Will it be a second home, or will you rent it out? There’s a big difference to lenders.
You must also ensure you qualify for the loan. Because you won’t live in the property full-time, lenders take a much higher risk lending you money. They’ll do their due diligence, ensuring you are a good risk and can afford the payments in addition to your current mortgage, if your primary residence still has a mortgage.
If you meet the relevant qualifying criteria, you can expect that most lenders will require a minimum down payment for a second home of 20% or more.