How to Refinance a Second Property

If you have a vacation home or investment property with an older, expensive mortgage, consider a refinance so you can take advantage of historically low mortgage rates.

At a time when financial constraints have forced some borrowers to sell second properties, refinancing can help make the property more affordable.

"You can borrow money at a very low rate, and that makes financial sense," says Gibran Nicholas, CEO of CMPS Institute, a national organization that certifies mortgage lenders and bankers in Ann Arbor, Michigan.

If you're able to lower your mortgage rate by 1 percentage point or more, it could save you thousands of dollars, says Michael Moskowitz, president of Equity Now, a mortgage lending company in New York City.

Refinancing a vacation home is not much more complicated than getting a loan on a primary residence. However, getting approved for any mortgage is much more involved than it was before the housing crisis, Moskowitz, says.

In order to qualify, you'll likely have to provide tax returns, several bank statements and proof of income to show your ability to repay the loan, he says.

However, there are some key differences between getting a mortgage on a primary residence, and securing a loan on a vacation or investment home.

Higher rates for second-home refinances

For starters, homeowners likely will pay a higher interest rate on the refinance of a second home or investment property.

Nicholas says that with a vacation home -- also known as a "second home" -- "interest rates are comparable to rates for a primary home," although you may have to pay one-eighth to one-quarter percent more.

Meanwhile, mortgage rates for investment properties usually run about 1 percentage point above owner-occupied residential mortgages, says Keith Gumbinger, vice president of HSH.com.

The amount can be more or less, depending upon whether fees are incorporated into the interest rate or not.

Fannie Mae's Loan-Level Pricing Adjustment matrix adds an investment property surcharge that ranges from 1.75 percent of the loan amount for mortgages of no more than 60 percent of the property value, to 3.75 percent for 80 percent loans. That translates to a rate increase of 0.5 percent to more than 1 percent.

Home equity is essential to refinance a second property

You will need to have equity in your property to refinance it -- plan on at least 20 percent, says Matt Hackett, mortgage risk manager at Equity Now. The home must appraise for an amount that is high enough to allow an acceptable loan-to-value ratio, he says.

That's a different standard than for primary residences, where homeowners may be able to qualify for Federal Housing Administration (FHA) financing with more lenient equity requirements, Hackett says.

It is difficult to refinance a second home if you have less than 20 percent equity. Moskowitz says it is possible to find a mortgage lender that will allow as little as 10 percent equity, but you may end up paying extra for it.

For example, you will probably end up paying for private mortgage insurance -- which can add nearly 1 percent to the payment -- in order to get the loan approved.

The difference between a second home and an investment home

There are some arcane rules for what constitutes an investment home versus a second home.

Usually, this hinges upon whether or not you need the income the property generates to cover the required mortgage payment -- in which case the property is likely to be deemed an "investment home" -- or whether your income without that cash flow can support the mortgage.

Not all lenders will finance investment homes, or finance all kinds of investment homes.

For a lender to deem the property a "second home" -- even if your income without the rent is sufficient -- the home must be a "reasonable distance" away from your primary home. That is usually akin to about 50 miles or so. It can be closer if the home is in an obvious vacation spot, such as near a beach or skiing area.

If it is just a plain old home not all that far from where you live, the property is usually treated as an investment since you really have no compelling reason to stay there instead of your primary home.

Also, to be considered a second home, guidelines generally state that the borrower must occupy the property for some portion of the year. If the property and occupancy fail these tests, the property is treated as an investment.

Fannie Mae also lists additional requirements for your second home:

• It must be a one-unit place, because duplexes, triplexes and fourplexes are generally rented out
• It must be suitable for year-round occupancy
• You must have exclusive control over the property -- no management companies and no time-share arrangements

What is more expensive to finance?

It is considerably more expensive and difficult to finance an investment home than a vacation home.

This is because when you refinance an investment property, the property's income is used to help you qualify for the mortgage. If something happens to that income, you may not be able to afford the loan payments.

Additionally, people may be considerably less attached to their rental across town than they are to their vacation house where the family celebrates July Fourth every year. As such, borrowers are statistically less likely to default on vacation homes.

Second homes and occupancy fraud

Many homeowners acquire an investment property by purchasing it first as a primary residence, then converting it to a rental when they buy a new home for personal use.

If you originally financed the property as a primary residence, the income from the property was not a consideration. But now, you will have to document the property's cash flow with your tax returns.

If it hasn't been rented out long enough for you to have a Schedule E, mortgage underwriters will credit you with 75 percent of the rent. (You will have to provide signed rental agreements and proof that the rent has been paid.) Or, an appraiser may be asked to create a rental schedule showing what the property should rent for.

Since refinancing a vacation home is cheaper and easier than refinancing an investment property, some owners are tempted to wrongly portray an investment property as their vacation home, says Hackett.

But they shouldn't bother, he says, because the lender will review monthly bill statements and other records to check on the accuracy of the loan application.

"From an underwriting standpoint, we spend a lot of our time figuring out if it's truly a second home," he says.

If you own a second property, consider refinancing while mortgage rates are still low for the chance to save thousands.

(Keith Gumbinger and Margarette Burnette contributed to this article) 

More from HSH.com:

Can my lender ask me why I am buying a specific home?

Refinancing? Use this document checklist

How to buy and finance investment property