How to finance a cabin or second home

Key insights:

• It’s necessary to qualify for a conventional mortgage to finance a second home or cabin.
• For the lowest rate and the best tax breaks, it may be best to avoid taking out a home equity loan to pay the down payment or closing costs on your second home.
• To avoid paying landlord taxes on your second property, do not rent it out for more than 14 days per year.

Whether you’re purchasing a vacation home in a warmer climate or buying a cabin on the lake in Minnesota or western Wisconsin, you’ll follow the same basic steps when it comes to financing a second home. Here are four tips to keep in mind when purchasing a second property.

1. Budgeting for a second home

While it can be exciting to search for the second property of your dreams, the first step in the process of getting a second mortgage is a bit less fun — budgeting. Your home mortgage consultant can help you organize your budget by analyzing your:

• Maximum mortgage payment
• Annual homeowner’s insurance policy
• Tax rates

This analysis, called pre-approval, is the best way to get reassurance about your buying power — which can be especially helpful when you are buying a second property.

2. Understanding conventional loan requirements

Federal Housing Administration loans, or FHA loans, are only available for primary residences. So, if you need financing when buying a vacation home, you’ll likely need to apply for a conventional loan. To put your best foot forward when taking out a conventional loan on a second home, experts recommend putting 20 to 35 percent down at closing.

Keep in mind that financing a second home tends to be a bigger risk for lenders, so it may be harder to qualify for a vacation home loan than it was for your primary residence. Even the most qualified buyers may be offered a slightly higher interest rate on their second home, as a way to protect the lender against that risk. To move the process along successfully, remain patient and provide your lender with any documentation they request.

3. Taking out a home equity loan

Your mortgage consultant can help you determine if you want to use your primary home’s equity to help pay for the closing costs or down payment on your second home. There is a catch to this arrangement: If you take out a home equity line of credit when getting a vacation home mortgage, you may end up with a higher interest rate.

When taking out a home equity loan on a second property, you’ll also want to consider potential tax implications. Depending on your financial situation, you may not be able to deduct all your mortgage interest from your taxes once you add in a second home. Seek out a tax consultant for guidance if you have questions about your taxes when getting a second mortgage.

4. Determining your rental strategy

Before buying a second home or lake cabin, you should know if you plan to rent the property out, and how often. Some lenders are hesitant to finance rental homes, while others may increase the mortgage rate on a rental property. If you do plan to rent your second home after purchasing it, be prepared to show your lender proof that you will be able to generate cash flow from that property. Also, know that the lender may consider only a portion of the estimated rental income when offering you the mortgage and your interest rate.

Consider the tax implications of a second home that is used primarily as a rental. If you rent the home for less than 14 days per year, you do not have to report any rental income to the IRS – even if your rental draws in thousands of dollars in those two weeks.

However, if you rent the home for more than two weeks a year, you’ll have to report all rental income. Rental platforms like Airbnb and VRBO can help you keep track of your rental income, but you’ll still have to keep diligent records of personal use versus rental use so you can appropriately deduct expenses like utilities, insurance premiums and more at tax time.

Last, depending on your location, you may have to pay state or local taxes on a property you rent out for any amount of time — and you may also have to register your property as a rental with your municipality. For help staying above board with your property, reach out to your city government for information on getting a rental license.

Moving forward with a second home or cabin search

The market for lake homes and cabins is red-hot and it’s important to work with a team who knows how to maintain your financial standing as you purchase your home away from home. Contact Edina Realty or your agent for help with your second home purchase.

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