5 Things to Know Before You Buy a Second Home

Buying your first home is a rite of passage that tends to require some handholding from a real estate agent. So, by the time you’re in the market to buy a second one, the whole process should be a piece of cake, right? Well, not exactly.

You have the benefit of knowing the basics from your first go-round, but there’s some new information that changes the game a bit when you’re buying a second home. Whether you’re making a real estate investment or buying a country house for weekend fun, here are some things to know about how to buy a second home.

1. Lenders may have stricter requirements for a second mortgage

Unless you can pay for your second home with cash, you’re going to need a second mortgage. Lenders will look at your debt-to-income ratio. They will focus on your credit score and the size of your down payment when you apply for a second home loan.

Because you’re borrowing a second large sum, which adds risk for the lender, second-home loans typically require more money down. This is generally at least 10 percent of the loan amount and can be significantly higher.

Lenders will also look for a higher credit score than when considering a loan for your primary home. Three potential sources of money you might use to cover a second downpayment include:

• A home equity loan—a lump sum of money that typically has a fixed income rate that you can borrow against equity in your existing property. It’s important to know that your first house could be in danger if you miss payments on the loan. Because your house is on the line, the interest rate is typically lower than other forms of debt.
• A home equity line of credit (HELOC)—this essentially means tapping the money you’ve already invested in your first home to pay for your second, without having to dip into savings as much. It is revolving credit, not a lump sum like a home equity loan. This means you can repay the money and easily borrow more.
• The cash value of permanent life insurance—you may be able to borrow against the cash value as a source of quick money, but keep in mind that doing so may reduce the value of your policy until you pay it back.

Financial professionals usually don’t recommend that you repurpose money in a retirement account to fund a second home.

 2. How you use your rental will impact what you can afford

How you plan to use your second home plays a major factor in what to look for, says John Muth, CFP®, senior director of sophisticated planning strategies at Northwestern Mutual. Decide whether you’re aiming for income through renting, including short-term rentals, or hoping to make money on potential price appreciation.

If renting out your second home is part of the plan, find out how much you can reasonably expect to charge by comparing similar rental homes in the area. You’ll also want to make sure the property has the features and amenities that will attract renters. If your second home’s mortgage payments and other housing expenses will exceed what you expect to take in, you may want to consider a less expensive house.

Also, mortgage lenders often charge more in interest if you plan to rent out the home. That’s because if you have difficulty keeping a tenant, you could have difficulty making your monthly mortgage payments. Likewise, if you’re relying on short-term rentals for income, the market could change, or lawmakers could prohibit short-term rentals (like Airbnb or VRBO). Pressures like these could leave you struggling to make your mortgage payments.

3. Your home credits and tax breaks might be different

Although there are a number of home credits and tax breaks for your first house, not all of them will apply to your second. “Everyone knows mortgage interest is deductible, but that’s deductible only up to a certain amount,” Muth says.

Because of the Tax Cuts and Jobs Act enacted in 2017, the cap on the mortgage amount eligible for deductions is $750,000. So, let’s say you have a $500,000 loan on your first home. If you need to obtain a $300,000 loan for your second home, the mortgage interest on $50,000 of debt is non-deductible.

Property tax rules and deductions for second homes can also vary depending on where you live and how often you occupy the home for personal use. Rules around whether you’re even able to rent can vary, too. In fact, some cities have made headlines for banning short-term rentals.

One thing that’s consistent nationwide: If you occupy the property and rent it out for 14 days or fewer throughout the year, your rental income is 100 percent tax-free. However, if you rent out the property for more than two weeks, you’ll have to declare your rental income and pay taxes on it. The upshot: 25 percent of your rental-related expenses—like utilities or the cost of a property manager—are tax deductible.

A tax professional can tell you which second-home tax breaks you’d qualify for. They can team up with a Northwestern Mutual financial advisor to help you map out your overall financial strategy.

4. Consider extra expenses outside the mortgage

When you predict the cost, remember to think about maintenance, repairs, renovations and redecorating. Property taxes will also add a significant chunk of money to your housing expenses.

If you buy a condominium or a home within a homeowners’ association (HOA), you’ll need to pay association dues. And, depending on the homeowners insurance on your first home, you may have to buy a second policy for your vacation or investment property. In general, second homes tend to be more costly to insure, especially if they’re going to be vacant for periods of time.

If you don’t have a realistic budget, this is a great time to type one out. Talk with a financial professional and see if your budget can accommodate a second property without sacrificing important elements like an emergency fund if something goes wrong.

5. You’ll need a plan for funding a second mortgage

Here’s the tricky part: Experts generally recommend your total house payments (including your mortgage, maintenance costs, taxes, etc. on all properties) shouldn’t exceed 28 percent of your gross monthly income. This number is referred to as your “housing expense ratio,” and it stays the same whether you have one property or several.

For example, if your monthly pretax income is $5,000, you should aim for a max of $1,400 a month on your combined mortgage payments. Keep in mind that the figure doesn’t cover other housing expenses that come with owning property.

Remember that there may be a big difference between what you qualify for and what you can comfortably afford to spend each month on both your first loan and your second home loan, says Muth.

You may have had a good experience with the lender for your first mortgage, but it’s still good to comparison shop. Your best approach, Muth says, is to talk to several lenders to find out what size loan you can qualify for. After seeing all your options, calculate the mortgage payment you’d be comfortable making each month for your second home.

As you sketch out a potential mortgage payment, remember that 25 percent of recent homes sold had a final sale price of more than their asking price, according to 2023 data from the National Association of Realtors. The same data showed that the typical downpayment for repeat buyers was 19 percent. The same data showed that the typical downpayment for repeat buyers was 19 percent.

A Northwestern Mutual financial advisor who knows your area and works with people like you can help you run the numbers and adjust your financial plan to make sure you’re still on track for your other financial goals.

Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the CFP® certification mark, the CERTIFIED FINANCIAL PLANNER™ certification mark, and the CFP® certification mark (with plaque design) logo in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.