If you’re planning to buy a second home, congratulations! As of spring 2017, some 9.26 million Americans reported owning second homes in this country.
Vacation home sales in 2016 were down 21.6 percent from 2015 but were still a substantial 721,000 home purchases, reports the National Association of Realtors. Such purchases accounted for 12 percent of all real estate transactions nationwide, with owner-occupied buys making up 70 percent and investor buys 19 percent. The median price was $200,000, up 4.2 percent from 2015.
“In several markets in the South and West — the two most popular destinations for vacation buyers — home prices have soared in recent years because substantial buyer demand from strong job growth continues to outstrip the supply of homes for sale,” explains NAR economist Lawrence Yun.
For many would-be second homeowners arranging financing, the question boils down to whether they should use cash or equity on their primary home (i.e., a home equity line of credit, or HELOC) to make up their down payment. After all, only 28 percent of vacation home buyers in 2016 were able to buy their home in cash, without need of financing from a financial institution.
Each down payment method offers its own advantages and disadvantages; consider how the following may affect your ultimate decision.
Potential Advantages of a HELOC:
- It won’t tie up your cash reserves, which you may need for other expenditures. “Even though a large down payment can help you afford more, by no means should home buyers use their last dollar to stretch their down payment level,” advises Tim Lucas on consumer news site TheMortgageReports.com. “Each buyer should come to his or her own conclusion, but it’s becoming more popular not to make a large down payment, for several reasons.”
- You may come out ahead by putting your available cash into investments instead.
- It usually offers lower interest rates than other loans.
- It’s usually secured quickly; lenders are confident about being repaid because HELOCs depend on the value of an existing asset (your home).
- Once you secure a HELOC, the terms won’t change based on your employment status or the fluctuating value of the home.
Potential Advantages of a Cash Down Payment:
- It typically lets you pay off your loan sooner, with lower required payments.
- It usually brings you lower interest rates, especially if your down payment makes up 20 to 30 percent of the sale amount.
- A large down payment may allow you to forgo mortgage insurance and other loan fees.
- It decreases the total tax benefit you’ll get from mortgage payment write-offs (this is known as a “passive loss”).
- It leaves the full equity of your first home intact should your finances change and you need that asset to fall back on.
- Having “skin in the game” may psychologically motivate you to make your monthly payments a high priority.
In general, you should also be aware that buyers of second homes are usually subject to higher interest rates because they’re considered a higher risk than first-home buyers. Why? Such buyers seldom or never live year-round in the second home, making it a higher liability as it becomes vacant or used by others without a financial interest.
Buyers of second homes also often face different tax laws and guidelines regarding the reporting of rental income.