real estate

How to Finance a Second Home

Thinking about buying a vacation property? Here's what you need to know.

Even when mortgage credit is easy to come by -- and it still is not -- the standards for second homes and restoration projects are tougher than for the purchase of a primary home.

Get a loan. Nearly half of vacation-home buyers in 2012 paid cash, according to the National Association of Realtor's "Investment and Vacation Home Buyers Survey 2013." Two-thirds of them made down payments of more than 20%. Where do they get the money? A home-equity credit line drawn on their primary residence is a favorite source.

Lenders consider second homes to pose a higher risk of default, so they impose special rules for getting a mortgage on them. They'll expect you to stay within the debt-to-income limits dictated by Fannie Mae and Freddie Mac. Your total monthly housing payments, including all mortgages, can't exceed 28% of your monthly gross income, and your total monthly debt payments, can't exceed 36% of your monthly gross income. Rental income from your first or second home generally won't count as stable monthly income for purposes of qualifying for a mortgage. Lenders may charge you a higher interest rate for a first mortgage on a second home (and certainly for an investment property).

For a reconstruction project, go to a bank with a detailed plan, projected costs and a schedule, and try to work out an arrangement in which the lender monitors the progress and funnels you the momey as you go. These are not permanent mortgages, however; they are short-term or bridge loans. You can refinance into a permanent mortgage when the work is completed. The interest rate on a construction loan will be a few percentage points higher than on a permanent loan, though the interest may be deductible.

Take a tax deduction. You're limited to deducting interest on no more than $1.1 million in principal for primary and vacation homes combined. You can rent your place for up to 14 days a year and pocket the rental income without having it on your tax return. If you rent it out for more than 14 days, the IRS considers you a landlord.

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