Refinancing a Second Home
For homeowners who can proudly say that they have successfully purchased a second home, we applaud you. Owning a second home can be a marvelous thing, and at the very least is an asset to hold on to for future generations. Even so, for a home buyer to get a second home typically means that they had to meet the near unreasonable eligibility requirements of lenders, have significant cash reserves lying around, and possibly tap into the equity that they built up in their primary residence.
Buying a second home is an incredible accomplishment, no matter how you slice it. Eligibility and financing aside, being able to handle the financial burden of not one, but two different monthly mortgage payments is far beyond the capabilities of most people. Of course, that isn’t to say that it can’t still be a burden.
While it may not be the case for all homeowners with second homes, refinancing a mortgage on a second home is not uncommon. In fact, the refinance process for a second home mortgage is actually almost as complex as financing the purchase of the home. It requires just as much patience, and funnily enough just as much proof (if not more) that the property will, in fact, be used as a second home, and not an investment property to rent out.
For people who own a second home and want to refinance, there are a few things worth knowing before jumping in head first. After all, an informed borrower makes much better financial decisions and has a much higher chance of getting the loan terms that suit them best.
Refinancing a Second Home
It is no secret that the current mortgage rates have been hitting some historical lows as of late. Needless to say, whether you’re looking at second home or a primary residence, it is a wonderful time to consider refinancing, since an interest rate reduction of even 1% can save a homeowner thousands in the long run. But for people who own a second home, the process can be a little more complicated than financing a primary mortgage.
For starters, while mortgage rates have dropped and home values have risen, leading to an amazing mortgage market with home purchases seeing an upward trend, mortgages for second homes still carry higher interest rates than those for primary residences. The very first thing a homeowner should consider is whether or not they can get a better interest rate on their second home, or whether it makes more sense financially to try to refinance their primary mortgage. With today's mortgage rates, it isn’t hard to imagine that financing a second home would be a complete waste, but it’s still worth the consideration.
If everything checks out financially, then proceed with the refinance. But keep in mind, refinancing a second mortgage is a little different from the standard mortgage refinance. Borrowers should always keep a few things in mind before getting started. Some important items worth noting are:
The Property’s Status as a Second Home Must be Verified
Even after all of the hassle about whether or not a home is a true second home and not just an investment property when initially financing the purchase of the property, borrowers will typically have to re-live this process when getting approval to refinance their second home. It isn’t some weird hazing thing either; instead, lenders view the financing of an investment property differently than they view the financing of a primary or secondary home. As it turns out, some second homes end up becoming rental properties, and lenders typically charge higher rates of interest on investment properties, so you can bet they don’t want to lose out on any interest they may be owed.
Mortgage lenders will need to be provided with reasonable evidence that the property will be utilized as a second home, and not as a rental property. There are a few specific things lenders will be looking for and expecting from homeowners and their second homes. The first and most obvious thing is whether or not the home is still being occupied by the homeowner for a portion of each year, even though the property must be suitable for year-round use.
Even with the information they have on the property, they will also reverify that the second home is still a single unit dwelling, and has not been converted into a multi-unit property such as a duplex or triplex. The borrower must completely own the property, in the sense that there cannot be a second party with claims to the property. They will also require that no timeshare arrangements have been made (with a slight exception that we’ll cover shortly) and that there is no management company or booking agency that arranges occupancy.
Rest assured, though, that verifying all of this is actually in the best interest of the homeowner as well, since second homes get the benefit of lower interest rates that rental properties. That isn’t to say that a little rental income will change how lenders classify a second home.
Second Homes Can Now Produce Rental Income
Due to the increasingly popular trend of homeowners renting their homes out on a small scale as a kind of “instant hotel” through sites like Airbnb, some lenders’ stance on rental income has shifted to better accommodate changes in the market. More specifically, Fannie Mae has updated its official rules on how lenders can treat second homes that make a little rental income in this manner. Short-term rental income has now become an acceptable trait for a second home, and should not hinder a refinance in any way.
According to Fannie Mae, homeowners who report rental income from their second homes should not have their properties reclassified as rental properties by lenders (as long as certain conditions are met). The first condition is that any rental income that is made cannot be used to meet income qualification criteria for the new loan. Additionally, the homeowner must still occupy the second home for a portion of the year.
If those two conditions are met, then Fannie Mae’s rules deem that lenders should still look at the property as a second home and not a rental property, and finance it as such. Of course, the property must also meet all of the other eligibility requirements of a second home as well.
Refinance Rates on a Second Home Aren’t Inflated
A common concern over refinancing a mortgage on a second home is that the rates will be much higher. While we can’t speak for the future, currently these are baseless claims. There are lenders who will raise the fees a little higher, most commonly when mortgage insurance is involved, but the interest rates for second home mortgages are actually only slightly higher than those of a primary mortgage. Fannie Mae’s loan level price adjustment guidelines consider second home mortgages on the same level as primary mortgages and therefore should be attributed similar interest rates.
Refinancing a Mortgage on a Second Home Requires More Equity
Probably the most noticeable difference between refinancing a primary mortgage and refinancing a mortgage on a second home is the emphasis placed on equity. Refinancing a mortgage on a second home takes a considerable amount of equity before it can be considered. As it turns out, lenders are very strict about the loan to value ratio (LTV) of a second home refinance loan.
Both Fannie Mae and Freddie Mac alike have set LTV limits on their second home refinance loans. This means that homeowners will need to have a certain amount of equity accumulated in their second home to qualify for a refinance.
The lowest equity acceptable for Fannie Mae is 10%, providing the new loan will have a fixed rate, and is a not a cash-out refinance. This quickly increases to a minimum of 20% for a refinance to an adjustable rate mortgage. Homeowners who would like to obtain a cash-out refinance must have at least 25% equity for a fixed rate loan and 35% for an ARM.
Freddie Mac has slightly different terms, including a 15% equity requirement across the board for fixed rate mortgages and adjustable rate mortgages if the loan is not a cash-out refinance. If the current loan is already owned by Freddie Mac, then the limit drops to only a 5% equity requirement for non-cash-out refinances. For a cash-out refinance through Freddie Mac, a solid 25% equity is required for both fixed rate and adjustable rate refinance loans.
Homeowners must have Substantial Credit Scores
Just like getting an initial loan for a second home, refinancing a mortgage on a second home requires some seriously good credit. Regardless of how current a homeowner has kept payments on both of their mortgages, a mortgage for a second home is still considered high risk by lenders. In addition, primary mortgages will almost certainly be paid before mortgages on second homes if things get rough, so lenders still need reassurance that borrowers will be able to stay financially reliable while roughing it out well into two separate mortgage loan terms.
Borrowers will usually need to have strong credit, much higher than the minimum 620 credit score required by Fannie Mae. In general, scores above 700 are recommended for no cash-out refinances, but there are some lenders who will accept scores as low as 680. Cash-out refinancing will require much higher credit, with lenders looking for nothing lower than 720 to be eligible.
Cash Reserves still Required for Refinancing a Mortgage on a Second Home
It may seem a little redundant, but homeowners will still need to have some cash saved up in order to get a refinance for their second home. It isn’t that crazy when you take into consideration that a refinance means getting a new loan. Lenders will still want to have some proof that the monthly payments can still be made if the borrower were to fall into a temporary financial hardship.
Typically, lenders expect borrowers to have at least two months worth of monthly payments for the second home -- enough to cover the total cost of principal, interest, taxes, and insurance (PITI). If the property is a part of a homeowner’s association, then homeowners will also be expected to have two months worth of HOA dues in reserve as well.
Refinancing a Second Home: Final Thoughts
Homeowners should not hesitate to reach out to a lender if they feel that its time to refinance the mortgage on their second home. There is always the potential of huge savings (especially with today’s mortgage rates) which could greatly reduce the burden of having two monthly mortgage payments to account for. The only catch is that homeowners must be prepared for the strict requirements of refinancing a second home mortgage.
Borrowers should be prepared to prove that the property has not been, and will not be utilized as a fully fledged rental property and that they do actually occupy the home from time to time. Second home refinancing still requires a strong credit score and some cash reserves as well. Most importantly, homeowners shouldn’t even bother bringing a refinance up unless they have some equity in the property.
All in all, it is a bit more complex than the average refinance, but it isn’t impossible. If there is anything else you would like to learn about refinancing a second home mortgage, or if you would like some one-on-one advice, feel free to contact the home.loans team for a risk-free consultation!