Financing a Second Home Now More Expensive, But Options Remain
Unfortunately for Baby Boomers, just in time for them to buy a second home, borrowing the money for one has become more expensive.
Baby Boomers (born between 1946 and 1964) represent a huge segment of the population in the United States. The U.S. Census Bureau reports that the 65-and-older population grew by over a third (34.2% or 13,787,044) during the past decade, and by 3.2% (1,688,924) from 2018 to 2019. The fastest increase of any age group. Although many are in their 60s and 70s, they are hitting their stride in income and savings and in wanting to own a second home.
As this population looks at buying a second home, there are considerations besides qualifying for the loan, evaluating the closing costs (2-3 percent of the loan amount) and going through the closing process. Buyers of second homes should make sure their budget can handle the extra monthly payments for the mortgage principal and interest, property taxes, homeowner’s insurance, HOA dues, routine maintenance, utility bills and possible major repairs.
Slowing the pipeline
But in terms of financing a second home, Freddie Mac and Fannie Mae have begun limiting how many second homes (and investment properties) they will provide mortgages for by putting a cap on those products that lenders can sell to them. The purported reason is the additional risk associated with second homes and investment properties.
And the fastest way to turn off the spigot and slow the flow of any given product, whether it is mortgages or perfume or macadamia nuts, is to change pricing. Sure enough, the pricing for second homes and investment properties, via loan level pricing adjustments, has worsened dramatically due to the actions of Freddie and Fannie.
Still, Freddie Mac and Fannie Mae are not the only game in town for lenders. But they do represent the lion’s share of the market and, thus, their effect on rates and markets. According to the Mortgage Bankers Association, recent figures show 16 percent of applications for all types of home loans are FHA, VA and USDA programs. The rest (84 percent) would be directed toward Freddie and Fannie, along with a scattering of private-label and portfolio products. Lenders will tell you that second home loans are not done through the FHA, VA or USDA programs for various reasons.
Second-home financing always different
So, the price of acquiring a second home or investment property has become more expensive due to the cap placed on lenders across the nation. Some lenders are pricing in 2.250 percent (percentage of the loan amount) or more for second homes. (As a reminder, 1 percent in fee equates to around 0.25 percent in interest rate.) Thus, an 80 percent loan-to-value (LTV) on a second home may now have a rate of about 0.500-0.625 percent higher in interest rate than a primary residence.
For many years conventional loans for vacation homes required a larger down payment than a primary residence, a higher interest rate and tighter guidelines. Even before the move by Freddie and Fannie, the minimum down payment for a vacation home was usually 20 percent, but many lenders have raised their minimum down payment requirement to 30% or 35% for a second home.
Because of the perceived higher risk with a vacation home (for example, if a borrower loses their job, making monthly payments on a second home will be less of a financial priority than their primary residence), borrowers need to meet higher credit score standards, possibly a lower monthly debt-to-income ratio, complete documentation of their income and assets, and high cash reserves.
And now, in addition to the loan criteria above, lenders are capped at selling this type of loan to Freddie or Fannie. Lenders, however, are a resourceful bunch and are seeking other outlets for this type of production. With that, however, comes higher rates and potential additional costs to be shouldered by borrowers.
Regardless of the age or demographic of someone buying a second home, many industry analysts point out that a limit to financing second homes or investment properties will negatively impact borrowing costs and have a broader impact on the short- and long-term rental markets. (For example, you will pay more rent to stay in a beach or mountain vacation home.) And is that what we really want Fannie Mae and Freddie Mac to be doing?
Beyond that larger question of monetary policy, the answer for most consumers who qualify will be that financing a second home is doable – it will just come at a bit more of a premium.
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