Most of us know where we’d like to own a vacation home. We also know how many bedrooms and what type of property we want. What isn't as clear is how we are going to finance buying a vacation home. However, it's crucial to understand the financial side of second homes if you are to make your dream a reality.
Whether you’re buying a condo for family vacations or are hoping to rent it out to form another revenue stream, you first need to know about financing a vacation home.
- Criteria for Buying a Vacation Home
- Ways of Financing a Vacation Home
- Guaranteeing ROI in a Vacation Home
*Please note: This blog isn't a substitute for professional financial advice and is intended for informational use only.
Criteria for Buying a Vacation Home
The process of buying a vacation home isn’t altogether different from buying a first home. The same offer and acceptance process applies and, as with any other property, the home will undergo a survey to check building work that may open up a negotiation between buyer and seller. Buying property abroad isn’t too complicated either, depending on your location.
However, the buying criteria for second homes are slightly stricter and lending arrangements change depending on what you plan to do with the property and where you purchase the property.
While all-cash buyers might not find much disparity in the purchasing process, those who need to find other ways to finance a vacation home will encounter subtle differences.
Stricter Buying Criteria
Buying criteria are stricter for second homeowners as lenders look at current property debt (if there is any) and the proposed borrowing amount. Generally, second homeowners must have:
- A higher than average credit score
- A larger down payment
- Financial reserves
Although credit score caps, down payment percentages and reserve amounts differ from lender to lender, buying a vacation home is generally something an individual needs to have the budget for upfront, rather than depending on future income to support a sale.
Lenders will want to see you have a low debt-to-income ratio and have plenty of cash in the bank to account for the unforeseen.
Individuals should make sure they can afford mortgage payments and cover the costs of interest, property taxes, insurance, maintenance and utility bills, as well as HOA fees and rental service fees if you're planning to rent your vacation home out.
Property Plans & Lending Arrangements
The purpose of buying your vacation home — as an investment or as an idyllic place to relax yourself — will determine which type of lending arrangement you can apply for.
For a property to be considered a personal residence, lenders may set requirements regarding the property’s distance from your primary residence and the number of days it will be occupied annually. Otherwise, your vacation home might be considered an investment property.
Investment properties are commercial assets and therefore require a commercial loan.
These properties are subject to different types of tax which can mean that monthly payments are more expensive when you account for the inclusion of other commercial property fees. Insurance is also likely to be higher on these properties as the risk of damage and the property being vacant for long periods is greater.
Commercial lending arrangements make it crystal clear whether you can rent out a holiday condo or a beachfront villa and there’s no getting away from them if you are to adhere to local letting law.
Ways of Financing a Vacation Home
As with buying a home, a vacation home is open to different types of financing, including options for investment properties:
The most straightforward way to finance a vacation home is through an all-in cash payment. With cash payments, buying criteria doesn’t apply and no lending arrangement needs to be drawn up.
Cash-out refinancing replaces your current loan and creates a larger mortgage agreement encompassing your old and new property.
Home Equity Line of Credit (HELOC)
A HELOC is a way to borrow against the equity of your home. This option isn’t always favored by lenders depending on your current financial situation and the estimated time it will take you to pay off the loan in its entirety.
A conventional loan is as it sounds, a separate loan to help towards payment of a property. Conventional loans typically prohibit other uses of your property, such as generating revenue through rental.
If you intend to rent your property out, you will normally need a commercial loan. . But you will pay a higher rate of interest for this, which is standard across the leisure property industry.
Owning a partial share of a vacation property is a way to participate in a low-risk investment and benefit from having a vacation home in a sought-after location for less money. Fractional mortgages are complex as lenders deal with more than one owner. You also won’t have the same rights as a sole owner of a property.
Financing a vacation home is surprisingly accessible to everyone, whether you’re in a position to buy upfront, pay a larger down payment or need to leverage existing assets to finance your purchase.
If you can’t afford to foot the cost of an entire vacation home, financing a vacation home with friends, family or fellow investors is another possibility.
In short, if you can avoid borrowing large sums of money, you should. Instead, find other ways to invest in a second home that presents little risk to sellers, developers and lenders.
A Second Income Stream
Financing a vacation home is only a small piece of the puzzle with most of us hoping for a second home to ‘take care of itself’ from a financial point of view.
Think of a solid income stream that can cover the costs of purchasing the home and then some. Yet, this doesn’t mean the proposed income can qualify you for a loan. To buy a vacation home, you’ll need to be in a position to finance it first and then reap its rewards later.
There are a few ways to create revenue from your vacation home:
The most popular option is rental income through short-term stays or more permanent tenants like remote workers and locals. If a management company, such as Hilton, manages your property, you can be sure your vacation home will benefit from higher occupancy rates and nightly rental rates.
Please be aware that government regulations prevent Non-Bermudian home owners from renting out their home without express permission from the Government Ministry.
A non-Bermudian who owns a condo hotel residence (like the ones at Bermudiana Beach) - can rent out short term to both Bermudians and non-Bermudians with a work permit, residential certificate or to any non-Bermudian staying for less than 180 days in Bermuda.
A plan for generating revenue alone won’t be enough to generate an income. You’ll also need to make sure you’re buying in the right area where demand for rental is high.
For example, short-term rentals will perform better if they are a short stroll from amenities, while long-term rentals will benefit from being in a more relaxed and suburban area.
Focus on what the area is like now and what it’s forecast to look like in the future. Consider looking into local government initiatives, regeneration and conservation budgets, other ongoing developments and policies in the area. The smallest details such as climate, access to airports and availability of activities can make all the difference in the popularity of your vacation home.
That’s why buying in Bermuda is such a smart investment.
Why Choose a Vacation Home in Bermuda
It’s home to a unique ecosystem as well as many lively locals and remote workers. Plus, it’s attracts honeymooners and discerning travelers in and out of season, making it an ideal rental opportunity.
If you’re ready to finance a vacation home — do it in Bermuda. Read our expert guide Why Bermuda? to see a full list of reasons why Bermuda is home to the best investment properties. Get access today using the button below.