When Graham Gullans bought his vacation home in Chatham last year, he knew in advance that he would finance it with a mortgage. “Mortgage rates were so low that they offered a really compelling reason to buy a second home,” said the 37-year-old tech company executive, whose main residence is in Boston.
Gullans closed a 2.75 percent mortgage to buy the property, which consists of a main house and a detached car home with a total of four bedrooms and five bathrooms, for $ 1,176,000.
Today, however, deciding how to pay for a vacation home can be more difficult. According to Freddie Mac, a 30-year fixed-rate mortgage averaged 5.25 percent on May 19, up from 3 percent a year earlier. Higher interest rates, which translate into higher mortgage payments, reduce the purchasing power of a vacation home buyer. Plus, with limited inventory and high demand from shoppers, the market is more competitive than ever, so some shoppers are getting more creative about finding the perfect weekend spot.
“The local residential market is very competitive, so people are doing things a little differently,” said Mary Mullin, a wealth management consultant for Merrill Lynch Wealth Management in Boston. “Ideally, you want to come in with a cash offer.”
Mullin said that in the past, if someone had a home in Boston or the suburbs and wanted to buy a home in Cape Town, they would do a cash refinancing. But despite the fact that exploitable equity (the amount that homeowners can access by keeping at least 20 percent capital in their homes) increased by 35 percent in 2021, to an aggregate total of nearly $ 10 trillion. according to data and mortgage technology firm Black Knight Inc. ., many holiday home buyers do not have enough wealth in their homes to pay for a second property. Also, Mullin said, many of his clients do not want to refinance now anyway because interest rates are much higher.
But a home equity line of credit (HELOC) allows homeowners to take advantage of their home equity while keeping the first underlying mortgage in place. And even if that capital is not enough to pay the full purchase price of a vacation home, it can allow a buyer to increase the amount of their down payment to better compete with other bidders.
Another option is to liquidate investments to generate cash to pay for a vacation home, but this can lead to tax liability. “People don’t want to charge a wallet and pay capital gains tax,” Mullin said. The solution: a line of credit secured by the investment portfolio, which offers buyers the opportunity to bid in cash. Then, once they close, they can mortgage the vacation home and pay off the line of credit. “It’s a good strategy,” Mullin said.
However, many vacation home buyers will finance their purchase with a traditional mortgage. Patti Lotane, a Cape Cod 5 mortgage loan officer in Chatham, said the state’s savings bank interest rates are the same for both main homes and vacations. Applicants must pay a minimum of 10 percent or 20 percent to avoid private mortgage insurance. Those who need rental income to qualify for the mortgage, or who apply for a jumbo loan, will need a higher down payment, up to 30 percent, Latone said.
In January, the Federal Housing Finance Agency announced increases in Fannie Mae and Freddie Mac’s initial rates for second home loans, beginning April 1, 2022. These rates make the Financing a second home with a mortgage that will be sold to Fannie or Freddie is very important. more expensive.
“Starting with deliveries to Fannie and Freddie in April, there are new rates for second homes,” said Bill Banfield, executive vice president of capital markets at Detroit-based Rocket Mortgage. “They range from 1⅛ points to 4⅛ at the highest loan / value ratio [LTV] and the lowest FICO score “.
For someone with good credit and a 75 percent LTV, Banfield said, the rate would be 2⅛ points, or $ 8,500 on a $ 400,000 mortgage. “It has had a bit of an impact on the financing of new second home purchases,” he said.
Allison Cameron Parry, a real estate agent for Douglas Elliman Real Estate whose market area is Nantucket and Martha’s Vineyard, said that for purchases of up to $ 6 million, its buyers are still using some form of financing. At higher prices, he said, many pay in cash.
Your clients are also getting creative to finance their vacation homes. Some are getting parents to sign their loan together so they can qualify, while others are buying second homes with friends or family to share the costs. Those who plan to use their vacation home as a rental business or investment property may, subject to the rules of the Internal Revenue Service, opt for a 1031 or similar exchange. Cameron Parry said a recent client did just that, selling a condo in Cape Cod and exchanging it for a house in Martha’s Vineyard while reversing the profit and deferring taxes on capital gains from the sale.
The method you choose to finance a vacation home will ultimately depend on your individual financial situation and risk tolerance. That is why it is prudent to consult an accountant or financial planner in advance.
“If you’re trying to weigh whether you need to get a mortgage, settle savings, or withdraw money from a retirement account, first look at what it will cost you in taxes,” said Mullin, the wealth management advisor. “Then look [your] monthly cash flow. You may be able to afford 20 percent, but what will your monthly budget payments do? “
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