Some borrowers with loans backed by the Federal Housing Administration find that after years of saving and paying off their current mortgage debt, they can afford to buy a second property. They also find that financing a second home, whether for rental or vacation purposes, costs a lot more than an FHA purchase. To finance a second property, you must rely on conventional financing, as the FHA's programs are intended for primary residences.
FHA Restrictions Prevent Second-Home Purchases
The FHA's mortgage insurance, which protects lenders in the event of default, is for buying or refinancing a principal dwelling that you occupy for a majority of the calendar year. You can maintain the home with an FHA loan as a principal dwelling, and buy another property to rent out for additional income, for pleasure, or both. In general, you don't need to refinance out of an FHA loan on your primary residence in order to buy a second home.
Cash Investment Required
Your ability to contribute a large down payment has significant bearing on whether a conventional lender can finance you. Conventional lenders require at least 20 percent down for the best interest rates and loan terms on a second property because the higher your down payment, the lower your loan balance and the lender's risk. Although a conventional lender may extend financing to borrowers with strong credit and income qualifications who have less than a 20-percent down payment, borrowers must consider whether it makes financial sense to put less money down and pay an increased monthly payment. Conventional loans with less than 20 percent down also require private mortgage insurance, which you must pay in monthly installments to protect the lender in case you default.
Long-Term Financing Requirements
In addition to having a hefty down payment requirement, a conventional lender for a second property must review your credit and finances and determine that you are a safe financial risk. Lenders compare your monthly debt load to your gross monthly income using debt-to-income ratios. Your debt-to-income ratio, which is expressed as a percentage, compares your total housing expenses for both the FHA-backed and conventional home loans. The ratio includes the costs of mortgage principal and interest, property taxes, and homeowners insurance, as well as any FHA mortgage insurance premium and homeowners association fees you owe. A total debt-to-income ratio also takes into account debt other than housing costs, including credit card debt and car loans. Conventional lenders typically consider a total debt-to-income ratio between 36 percent and 42 percent an acceptable debt load.
When Considering Cashing Out to Buy
Unless you plan to cash out equity on your home bought using the FHA loan for a down payment on a second home, you don't have to get rid of your FHA loan or even notify the FHA lender. FHA allows you to cash out up to 85 percent of your home's equity with a new FHA loan, but you are expected to disclose plans to subsequently buy a second home with the money. FHA lenders must ensure that if you use the cash proceeds to invest in another property, you can handle both the FHA and conventional housing costs. Lenders require a copy of the purchase contract and the terms and payments of the new conventional loan.
- US News: Are You In Over Your Head?
- Nolo: Buying a Second Home in Seven Steps
- Consumer Financial Protection Bureau (CFPB). "Conventional Loans." Accessed Mar. 14, 2020.
- U.S. Bank. "Conventional Loans." Accessed Mar. 14, 2020.
- Consumer Financial Protection Bureau (CFPB). "What Is a Conventional Loan?" Accessed Mar. 14, 2020.
- Federal Housing Finance Agency. "FHFA Announces Maximum Conforming Loan Limits for 2020." Accessed Mar. 14, 2020.
- U.S. Department of Housing and Urban Development. "Annual Report to Congress Regarding the Financial Status of the FHA Mutual Mortgage Insurance Fund, Fiscal Year 2019," Page 10. Accessed Mar. 14, 2020.
- Consumer Financial Protection Bureau (CFPB). "Debt-to-Income Calculator." Accessed Mar. 14, 2020.
- Consumer Financial Protection Bureau (CFPB). "What Are (Discount) Points and Lender Credits and How Do They Work?" Accessed Mar. 14, 2020.
Karina C. Hernandez is a real estate agent in San Diego. She has covered housing and personal finance topics for multiple internet channels over the past 10 years. Karina has a B.A. in English from UCLA and has written for eHow, sfGate, the nest, Quicken, TurboTax, RE/Max, Zacks and Opposing Views.