If you’ve built up a significant amount of equity in your primary residence in the last few years, you might be tempted to purchase a second home. However, you will likely need to take action relatively soon to avoid rising mortgage rates.
Here’s what you need to know about the 2022 outlook on mortgage rates for second homes:
Can You Finance a Second Home?
If you’re interested in purchasing a second home, you don’t necessarily have to pay for this property in cash — there are ways that you can finance this purchase.
That being said, it’s often more challenging to qualify for financing on a second home compared to a primary home. For example, lenders typically require higher credit scores, higher down payments, and substantial cash reserves.
Although the exact qualification requirements vary by lender and loan type, most of the time, you will need to have a credit score above 640 and a down payment of at least 10%. Plus, you will need between two to four months of cash reserves left over.
As opposed to your first mortgage, buying a second home is considered to have a higher risk. Compare these requirements with those for financing a primary home: a credit score above 620, a down payment of at least 3%, and potentially no cash reserves.
So this means that if you’re purchasing a vacation home for $400,000, your down payment would need to be at least 10% at $40,000. If you’re making this purchase using a 30-year fixed-rate conventional loan with a 4.5% interest rate, your monthly mortgage payment would be around $1,824.
To meet the cash reserves requirement, you would need to have between $3,600 and $7,300 left over after paying the down payment and closing costs.
How To Finance a Second Home
There are several different ways that you can finance a second home, including a home equity loan, a conventional loan, and a bridge loan.
Let’s discuss these different financing options more in-depth so that you can make an informed financial decision on your second mortgage:
Home Equity Loan
A home equity loan (or home equity line of credit — HELOC) is one way that you can finance a second home. Since you’re already a homeowner, a home equity loan allows you to access the equity you’ve built up in your primary home and use that to finance the purchase or at least the down payment for a second home.
With a home equity loan, you can typically take out up to 85% of the home’s value, although the exact amount depends on your credit score, income, and assets. And while home equity loans typically give you access to lower interest rates, they also come with higher risks since you’re using your primary home as collateral.
This means that if you’re unable to make payments on your home equity loan, the lender could potentially foreclose on your primary home. Additionally, it’s important to remember that home equity loans aren’t free. They come with closing costs, just like other loans that don’t necessarily involve putting up your primary home as collateral.
A conventional loan is another way to finance a second home and is perhaps the most popular option. The odds are that you currently have a conventional loan for your primary home mortgage, and you can actually use this same type of loan for a secondary home as well.
One of the biggest advantages of using a conventional loan is that you’re typically able to receive a better interest rate. In exchange for these lower rates, conventional loans come with stricter qualification requirements that can be difficult for some buyers to meet.
A bridge loan is yet another way that you can finance a second home. Bridge loans differ from home equity loans and conventional loans in that they’re a short-term solution. Instead of having terms that range anywhere from five to 30 years, bridge loans typically come with terms of just one year.
During this one-year term, you only make payments on the accrued interest of the loan. At the end of the one-year term, the remaining balance becomes due and is usually paid off by another loan.
As a result, a bridge loan is designed to “bridge the gap” between closing on your second home and securing permanent financing for the property.
What Are Mortgage Rates for Second Homes?
We’ve touched on mortgage rates a bit already, but now it’s time to really dive into the subject that’s been all over the news lately.
Are Mortgage Rates Always Higher for Second Homes?
Mortgage rates for second homes are almost always higher than the current market rates for primary homes. That doesn’t necessarily mean that rates for second homes are unrealistically high. In fact, the rates for second homes right now may actually be less than your current rate on your primary home.
This is because mortgage rates are currently close to record lows, meaning that if you’re interested in purchasing a second home at a favorable rate, now is the time to do so.
Current Second Home Mortgage Rates
Generally speaking, you can expect to pay around 0.5% more in interest for a conventional loan on a second home compared to a primary home. For example, if interest rates average around 4.0% for a 30-year fixed-rate primary conventional loan, you’ll likely have to pay around 4.5% for the same loan on a secondary home.
If you’re using a home equity loan to finance the purchase of your second home, rates are currently a little bit higher — around 6.0% for a 15-year fixed-rate loan. Alternatively, bridge loan rates currently range from 6% to 10%, depending on your qualifications.
What Is the 2022 Outlook for Second Home Mortgage Rates?
Although rates are low right now, they aren’t expected to stay that way due to a couple of different reasons.
The Federal Reserve
For starters, all mortgage rates for primary residences, secondary residences, and investment properties are expected to increase this year as the Federal Reserve plans on a series of rate hikes. The Federal Reserve has kept rates low for the past two years as the country has battled the COVID-19 pandemic and the resulting economic slump.
However, as the COVID-19 pandemic comes to an end and the economy ramps back up, the Federal Reserve is taking action to reduce inflation rates by increasing interest rates.
Right now, rates are at 0% to 0.25%, but five rate hikes are expected throughout the rest of 2022, starting as early as March. Rate hikes are also expected to continue into 2023, so it’s probable that we won’t see rates this low for a very long time.
The Federal Housing Finance Agency
Additionally, the Federal Housing Finance Agency (FHFA) has announced that it is going to be increasing fees on second home mortgage loans starting on April 1, 2022. According to the FHFA, upfront fees for second home loans can expect to see increases between 1.125% and 3.875%, depending on the loan-to-value ratio and other factors.
And while these fees are charged to lenders, lenders will be increasing their own rates accordingly to offset these fee increases. At the same time, it’s important to note that this doesn’t necessarily mean that second home borrowers will see fee increases of nearly 4%.
Instead, it will be up to the lender how much they increase their charges. Nevertheless, rates for second homes are going to rise as a result of these increased fees.
How To Get the Best Mortgage Rate for a Second Home
With all this information in mind, how can you get the best mortgage rate for a second home?
Here’s a step-by-step guide on what you need to do:
Step 1: Improve Your Credit Score
One way that you can get a better mortgage rate is to improve your credit score. Just because you’re technically able to get a loan for a second home with a credit score of 620 doesn’t necessarily mean that you should. This is because lenders are going to charge you higher interest rates to offset the risk that they’re taking by lending to you with your low credit score.
To qualify for the best interest rates, you need a credit score that’s above 760. But how can you improve your credit score?
Here are some tips to help:
Avoid taking on new debt or opening up new credit cards
Make at least the minimum payment by the due date
Pay more than the minimum payment to reduce your debts
Step 2: Save Up More Money
Another way that you can get a better mortgage rate is to save up more money for your down payment and cash reserves. Again, just because you’re technically able to secure a loan for a second home with just a 10% down payment doesn’t necessarily mean that you’re getting the best interest rate.
Instead, you should try to save up more money to come up with a down payment that’s at least 20% of the home’s price. Additionally, you should try to save up even more money to show that you have plenty of cash reserves left over after the purchase, as doing so decreases the risk for the lender and may result in a lower interest rate.
Step 3: Shop Around With Different Lenders
Shopping around with different lenders to locate the best rate is always recommended, no matter what type of loan you’re using. Experts recommend that you receive quotes from at least three different lenders to make sure that you’re getting the best rate possible. Even a seemingly small difference of 0.25% can save you a ton of money throughout the term of your loan.
For example, let’s say that you receive one quote of 4.5% on a $360,000 30-year fixed-rate loan. This means that your monthly payment would be $1,824. You would pay nearly $297,000 in interest over the term of the loan.
Alternatively, let’s say that you got another quote of 4.75% on the same loan; your monthly payments would be $1,878. You would pay over $316,000 in interest over the term of the loan — $16,000 more than you’d pay with the other quote.
Step 4: Lock in Your Rate as Soon as Possible
Finally, if you’re ready to buy a second home now, you need to lock in your rate as soon as possible as rates are expected to rise throughout the year due to action taken by the Federal Reserve and changes put into place by the FHFA.
Reach out to Vaster today to start the process of financing your second home before mortgage rates rise even further. Vaster is a mortgage private lender that offers a variety of customized financing solutions for second homes and investment properties. If you’re ready to go, click here to get started on your application.