Are You Ready for a Vacation Home?

by Michael Licamele

Residential Finance Network offers borrowers a full selection of loans for vacation homes (referred to as second homes in mortgage lending). Down payments are low and interest rates are the same as for mortgages on a borrower's primary residence. Before jumping into a vacation home, take time to review the positive and negative aspects below.

Is it a beach cottage on the ocean? A lakeside home in the country? Or a ski house in the mountains? Whatever vacation home fantasy is on your mind this summer, it could be time to consider owning that dream and not just renting it. For many families, there is no better vacation than returning to the same home year after year, to build a lifetime of happy memories at "the summer house."

Before jumping into that home, potential buyers would be wise to consider the real pros and cons of owning a vacation property as opposed to just renting.

Are You Ready for That Vacation Home?

Obviously, a vacation home is not the optimal choice for the traveler. Those who always need someplace new to visit and get bored staying in one place should not even consider buying a permanent vacation home. Buying a summer home means making a commitment to one geographic location and a lifestyle. Without a strong desire for the vacation home lifestyle, a consumer is wise to consider possible alternatives. On the other hand, for those who work hard and like to get away from it all and relax on vacation, a second home by the beach, a lake or mountainside resort may be the perfect getaway. For many families, a vacation home also gives parents a good base from which to take care of children.

My father, Joseph Chisholm, purchased a summer home in Laurel, New York on the North Fork of Long Island back in 1972. In 1997, my parents decided to retire there after spending 26 fun-filled summers on the shores of the Great Peconic Bay. He says, "One advantage of a summer home at or near the water is that it is a tremendous chance for relaxation. If you have young children or grandchildren, it is a wonderful environment for them to learn how to swim, sail and enjoy their summers." Mr. Chisholm points out other hidden advantages of owning, commenting that "you can always rent it at a fair price for a short period and cover some of your expenses. The second reason to own a summer home in a choice location is that you can swap it for other places in the world for a as little as a week or up to a season for an occasional change. It's not very hard to arrange-many Realtors can help you find a willing party."

Our family rented in the immediate area for several years before deciding to buy a summer home there. We advise vacation home buyers to experiment with different vacation destinations, then rent in the area for at least one summer before actually buying. Spending a month or an entire summer in an area gives a good indication of what owning there would actually be like.

Is Joint Ownership a Good Idea?

Sharing the cost and upkeep of a vacation home with family members or close friends is an alternative to buying alone. Before considering this option, buyers must first find people who share the same vacation home goals as themselves and have the financial capability to share in both the purchase and the on-going costs. Potential partners should be immediate family or long-term friends-people who with whom you will feel comfortable making rules and enforcing them, as well as managing the day to day maintenance of the property.

Sharing a vacation home also often means sharing a mortgage to help purchase the property. Borrowers should be extremely cautious and make sure that potential partners do not financially overextend themselves to participate in the purchase. If problems occur down the line, it is possible that another partner may be unable to continue payments, leaving the remaining partner or partners with all of the expenses to pay. A partnership agreement drafted by an attorney should definitely be used for anyone considering buying real estate with friends or family. Because of the many potential pitfalls of buying a home with partners, vacation home buyers should probably shy away from this option unless the property is so spectacular that sharing it would be a better option than having sole ownership of a smaller property.

Financing Your Vacation Home

Most lenders now allow buyers to purchase vacation homes with a 10% down payment. To qualify, a borrower's total debt burden should not exceed 40% of his or her gross monthly income. Total debt burden for this purpose is defined as the principal, interest, taxes and insurance payment on both a primary residence and the vacation home, along with all other monthly debt payments. For borrowers who meet this qualification, along with other normal credit requirements, nearly every loan program is available at standard pricing (i.e. for the same rates you would normally get on your primary residence).

Many borrowers obtain the down payment for their vacation home by taking out a home equity line on their primary residence. If the borrower can afford the monthly debt payments of the equity line, this technique can be an easy way to get the cash for the vacation house. Almost all lenders allow borrowers to use equity lines for down payments on other homes (see Home Equity article in this issue).

Four issues often arise when a borrower applies for a vacation home loan. One occurs when the property being purchased is a condominium form of ownership. Most lenders require condominiums to be primarily owner occupied and may not finance a home in a project where investors own more than 40% of the units. Vacation homes often are owned by investors and rented out for part of the year, so it is important to find out details of the association before making an offer.

The second type of problem arises when a vacation home is a two-family property. There are many summer homes that have a main house and an apartment that is rented for income purposes or occupied by a caretaker. Fannie Mae and Freddie Mac guidelines at present do not allow vacation homes to be more than single family properties. Although exceptions may occur, a borrower might be better off contacting a local portfolio lender to finance a vacation home with more than one dwelling unit.

Third, most mortgage guidelines dictate that a vacation home can not be in the same local area as a borrower's primary residence. Lenders make every effort to insure that borrowers are not using the second home program for investment purposes. For most borrowers, this is not a problem. But in many areas it is common to vacation locally, so buyers should be prepared to make their case to a lender to prove that a local property will be used for vacation purposes only.

Finally, vacation home owners will find it more difficult to borrow against existing equity if they seek to execute a cash-out refinance of the property. Although a consumer can borrow up to 90% of the value of a vacation home to buy it, most lenders only allow owners to refinance up to 75% of the current value of the property. Those consumers seeking to use equity in the property in later years for college educations, for example, should make plans keeping this factor in mind. Equally important, vacation home owners should be aware that values fluctuate wildly during economic downturns, as vacation home markets get hit much worse than normal home markets.

A vacation home can be utilized as an investment to decrease costs, but leasing to other vacationers is much more than simply cashing a rent check and always involves tenant management. (See Real Estate Investor article in this issue). Essentially, owners who rent their home out will be in the hospitality business, and must be prepared to meet the needs of vacationing tenants. Renting on a regular basis is almost the same as sharing ownership in that the property will be used by more than one occupant.

Although there are several pitfalls to financing a vacation home, adequate financing is readily available to qualified buyers. The mortgage markets today have more than sufficient programs to meet the needs of vacation home buyers. And despite all the potential problems that can occur, there is certainly nothing better than lying on your own stretch of beach in the warm sun with the waves lapping at your feet and the gentle summer breeze blowing.

Michael Licamele is President of Residential Finance Network.