This post originally appeared on The Basis Point: Second Homes Are Overrated (said the person who doesn’t get it)
Even the mighty Bloomberg team can succumb to clickbait, like their “Second Homes Are Overrated” headline last week. The piece says “according to Redfin,” 48% of mortgages locked on homes in May were on second homes, and buyers in this market might face “especially disastrous” factors like overpaying, higher mortgage rates, maintenance, and trouble renting the place. These factors are either wrong or presented without getting how it really works. So let’s cover 6 key notes you must know as a second home buyer.
First, the rate lock citation is wrong. The data was noted in a Redfin story but isn’t from Redfin. It’s from a company called Optimal Blue that powers consumer rate quotes and locks for over 1,000 U.S. lenders. This represents about 35% of a total U.S. mortgage market that locked and funded 11.99m mortgages last year and is expected to fund 10.1m this year (per MBA). Here’s Optimal Blue’s daily rate quotes, which are among the most accurate sources out there because the rates are based on real deals rather than surveys or averages.
Second, higher second home and rental property costs are just fact, not “disastrous.” Mortgage rates and down payments run in 3 tiers: (1) lowest rates and down payments for primary residences, (2) slightly higher rates and down payments for second homes, (3) higher rates and down payments for rental properties. You can put 5% or less down on a primary home, but typically need 20% or more down for a second home (especially for optimal rates), and rates/down payments escalate for rental properties. A new rule this year (for mortgages $548,250 and lower) restricts how many second home and investor property mortgages lenders can sell to Fannie Mae, and this has led to higher rates and down payments on these loans in some cases. But the math is specific down to the loan, borrower, and property level. So blanket statements don’t apply. If you’re looking to buy a second home or investor property, you must have a local lender quote you. When you do, you’ll likely see these down payment and rate adjustments don’t box you out like the headlines claim. This is especially true for second homes.
Third, here are the key lender AND local rules for renting a second home. If you finance a second home, you have rental restrictions. When you get a mortgage you sign a note (which spells out your rate, payment, repayment timeline, etc.) and a deed of trust (which says you must repay your mortgage per the note terms, keep the property insured, pay your taxes, and keep the property in good repair or the lender can call your loan due). The deed of trust also defines your occupancy status. A second home deed of trust says you’ll occupy the home just like a primary residence deed of trust says. But you also must sign a rider that amends your second home deed of trust to say: you can only do short-term rentals and you can’t use a property management company in year one. Then you have more rental flexibility after that. Also note that lenders won’t allow you to use rental income to quality for a second home purchase. They will allow it for a rental property purchase, and you have no rental restrictions when using a rental property loan. See item 6 below for tax notes on second homes. And don’t forget: all local areas have rules about short vs. long-term rentals. Sometimes whole cities restrict short-term rentals, and sometimes cities have specific areas of town that allow short-term rentals. If you want/need to rent a second home, press your realtor to help you find this out BEFORE you fall in love with a place.
Forth, everyone knows home prices are higher in 2021. So let’s not pretend it’s a calamity if it’s tough to engage in bidding wars to win a deal. If you’re buying a second home or rental property, you’ve likely had some exposure to the housing market. So just do the math (with help from your lender and realtor) based on your price, budget, and time horizon — then you make your offers until you win. This is how all investing works, and 7 million existing and new homes will sell in America this year, so the market has room for you. Headlines don’t matter. If you read a media story citing stiff competition in your local market, please remember that your borrower profile (and each property profile you bid on) is different than whatever blurb you read in a story.
Fifth, Duh: maintenance! (And how to win a bidding war) Like buyer competition, maintenance is also part of homeownership. Even more so when sellers have the upper hand and don’t have to fix up homes as much (if at all) to sell in a market like this. You must write competitive offers get the homes you’re targeting, and there are timelines (called contingencies) you can put on how long you need to get financing, get an appraiser to determine the home’s value, and get an inspector to scour the home for quality and defects. To compete in a market like this you must keep these contingencies short, but press your lender and realtor for help on getting these things done VERY fast so you can write a competitive offer while also doing your proper due diligence. Two other things: (1) if you’re buying a second home or investment property, condos can reduce maintenance burden from afar because big components of the property are maintained by the homeowners association dues you pay, and (2) New plays like Pacaso can also ease the maintenance burden for second homeowners because you pay into a plan that maintains the home — but this is a fractional ownership model which has other complexity.
Sixth, tax treatment on second homes: A great benefit of second homes is that mortgage interest and property taxes are treated the same as your primary residence — IF you live in it more days than you rent it per year (per the IRS). And remember: you must comply with both lender and IRS rules, so re-read item 3 above and discuss the rental rules in your second home deed of trust with your lender.
Second homes (and rental homes) are a great-but-technical investment for anyone whose objectives, budget, and time horizon match up — just like any other investment. Revised 2019 lender rules made it easier to rent second homes and revised 2021 lender rules make both second home and rental home rates higher. But second home rates are still crazy low by historical standards, so this combined with easier rentability give second home buyers attractive options.
Hope these notes help, and please comment below with questions or ping me directly — there’s definitely a lot more to unpack about how to handle your tax benefits on a second home.
– Note: the town pictured has a short-term rental district south of the main street line.