Refinancing & Other Issues

Financing a Vacation Home

Getting The Down Payment Together to Buy a Vacation Home

In today’s lending environment, the standard down payment is 20%. When you also factor in the fact that housing prices have increased over the last decade in most parts of the country, you realize that affording the monthly mortgage payment isn’t necessarily what keeps folks from owning their own homes.  It’s coming up with the money for the down payment. So, once you decide you’re ready to take the big step and purchase a vacation home, you need to realistically assess your resources and determine what you can afford. 

Examine Your Resources Carefully

Source 1: Your Own Savings

Presumably, you’ve been putting money aside in a separate fund to buy a vacation home.  Today’s down payment requirements make it close to impossible to purchase real estate unless you’ve got a considerable stash put away.    If you don’t feel comfortable with the amount you’ve managed to put away, we can give you ideas on how to boost your savings rate.

Source 2: Your Other Assets

Too often, we think of available cash as just that: money we have managed to save in savings accounts, money market funds and CDs.  We lose sight of other assets which we own when, if sold, may lead to significant additional sources of money. You may have a considerable amount of savings bonds that your grandparents gave you each holiday. Or, what about that stock that was given to you when you were a child? Do you participate in a company stock purchase program? Don’t think of just cash; think of items that you can convert to cash as well.

Source 3: Gifts From Parents and Relatives

If you are fortunate enough to have family members that want to give you money, you can certainly use it to pay for the property.  Anyone can give up to $12,000 per year, or $24,000 per year if it is a joint gift, to as many people as they wish without having to pay federal gift taxes. So, each parent (or grandparent) can give you $12,000. If you’re married, your in-laws could do the same, if they have the money. If both spouses have two living parents, that could be a total of $48,000!  The person receiving the gift is not required to pay income taxes on any amount received.

Source 4: Family Loan

If a parent or relative is not willing to give you the money you need, perhaps they would consider lending you the money instead. The important thing to remember here is that they should charge you a reasonable interest rate, reasonable meaning that it is based on current market rates. Make sure that you have a written, enforceable note (a legal document) that clearly spells out the terms of the loan. Without this note, the Internal Revenue Service may decide that your loan is really a gift and impose gift taxes on the loan. Consult your tax advisor for more information.

Make sure that the terms of the note stipulate that it is collateralized (secured) by the property.  In that way, the interest on the loan would be deductible for Federal income tax purposes.

Many lenders will not allow you to use borrowed money for your down payment.  Check with your lender for details. 

If you have to rely on a loan from your relatives to purchase a vacation home, your financial situation may not warrant the purchase. 

Source 5: Equity Sharing 

Through this arrangement, relatives, frequently parents, lend you the money for the down payment and in return receive interest income from you plus a piece of appreciation in the property. For example, they may receive 7% interest and a 50% stake in the appreciation on the home in return for lending you $20,000. As an alternative, the ‘investor-relative’ provides the down payment and you, the ‘occupant-owner’ pay the closing costs, monthly mortgage and upkeep. Eventually, both parties split the profits on the appreciation and when the home is sold, the down payment is returned to the investor-relative.

Source 6: Renting with a Buy Option 

This gives you the right to buy a home you are renting within a specified time period, say one to three years, at a negotiated price. Part of your monthly rent payment goes toward building up the down payment. Most rent-with-the-option-to-buy plans charge the renter a fee, ranging from $1,000 to $5,000.

Source 7: Private Mortgage Insurance (PMI)

A lender may grant a mortgage if you have a small down payment, if you buy PMI.  PMI is sold through banks and mortgage companies to cover the difference between a lower down payment and the 20% usually required by most lenders. It insures that should you not be able to make your mortgage payments and your home is foreclosed, the PMI company will make good on a pre-determined percentage of the outstanding balance, thereby reducing the lender’s loss. While this is not a source of funds, it lowers the amount the lender will require from you. 

Source 8: Life Insurance Loan

If you have a cash-value life insurance policy, you can borrow against the cash value, often at reasonable interest rates. When you do, however, your death benefit is reduced by the amount you borrow. That means that if you die while the loan remains outstanding, your heirs will receive less than the policy’s face amount.

Although you can basically set your own repayment schedule on a life insurance loan, if you don’t repay the loan and enough interest expense accumulates, you could lose your insurance coverage and possibly be forced to pay taxes on part of what you borrowed.  Whenever you borrow money, make sure you have a plan to pay it back.

Source 9: Retirement Plans

You may be able to borrow against a defined contribution retirement plan, such as a 401(k) or company profit-sharing plan. You must repay the loan within five years, although loans used to purchase or substantially improve your home can have a longer payback period. The interest expense is not tax deductible. Employers may impose other limits on this type of loan.

Source 10: Loan Guarantee Programs

If you are eligible, the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), or the Farmers Home Administration (FmHA) all have loan programs that require little or no down payment to qualified buyers. Also, most states have subsidy programs in place for first time homebuyers. Check what’s available by calling your state’s housing agency.