How to refinance a vacation home

Refinancing a vacation home has the same advantages as refinancing your primary residence — it may help you save on interest costs, or lower your monthly mortgage payment.

But the refinancing process differs for a vacation home. The mortgage interest rate on your second home may be higher than what you pay for your primary residence. And there may be tax consequences to take into account.

Can I refinance a vacation home?

In most cases, you can refinance a vacation home. Refinancing a vacation home can have many advantages, including:

• Allowing you to take equity out of the property to consolidate debt
• Refinancing into a shorter term to reduce total interest costs
• Converting a variable-rate mortgage to a fixed-rate loan
• Scoring a lower interest rate than the one on your current mortgage

If you’ve gone through the refinancing process before with your first mortgage, you’ll find it to be very similar. The main difference is that you’ll have to show that your vacation home is not a rental property.

Second home or rental property?

Lenders consider a vacation home a second home that you live in for at least a portion of the year. This may be months at a time or on the weekends. It’s a property that’s primarily used by you, the homeowner. By contrast, a rental property is one that you own but is occupied by a tenant, who pays rent. The tenant can either be long-term or renting for a short period of time while on vacation.

While it’s not necessary, you may earn passive income from a rental property. Since lenders consider second homes "less risky" than real estate investment properties, they’ll likely grant you a better interest rate if you have one. So it’s important that you can prove your vacation home is, in fact, a second home rather than a rental property.

How to refinance a vacation home

The steps to refinance your vacation property are similar to those you would take to refinance your primary residence — with a couple of important differences. Here’s what you need to do.

Ensure you have a vacation home

The IRS has specific guidelines for what qualifies as a vacation home versus a rental property or real estate investment property, which mortgage investors Fannie Mae and Freddie Mac also follow. For a house to be considered your second home, you (the borrower) must live in it for 14 days during the tax year or 10% of the days in which you would’ve otherwise rented it at fair rental value, whichever is greater.

Check your credit

If your credit score has improved since you first purchased your vacation home, you may be able to lock in a lower interest rate. Before you begin the refinancing process, check your credit report and credit score so you know exactly where you stand. If you notice any inaccuracies or errors on your report, dispute them right away.

Gather paperwork

To refinance your vacation home, you’ll need to share a number of documents with the lender. These may include your federal tax returns, W-2s, and 1099s from the past two years. If you receive child support or alimony, you’ll need legal paperwork that shows the payments have been made for at least six months and will continue for a minimum of three years.

Shop around and choose a lender

Do your research and look for multiple lenders that offer refinancing for vacation homes. Read reviews and compare the pros and cons of each option. This can help you land the best rate and terms, and find a reputable lender.

Read the fine print

Some lenders may charge fees for refinancing your vacation home. These expenses can include escrow fees, appraisal fees, Private Mortgage Insurance fees, and origination fees. Once you have a lender in mind, be sure you’re aware of these fees to avoid unwanted financial surprises down the road.

Wait for approval and close

After the lender approves and finalizes your loan, it will send over closing disclosures you’ll need to review and sign. Be patient, as this may take some time depending on the lender you choose and the time of year you apply.

Refinance rates for second homes: What to know

Refinance rates for second homes are typically a bit higher than they are for primary homes. The higher interest rates are because lenders believe if you hit a financial roadblock, you’re more likely to stop paying your second mortgage than the one on your primary residence.

Still, if your credit is good, you may be able to refinance at a lower rate than your current mortgage rate.

Rates vary from lender to lender, so it’s important to shop around.

Credit, reserves, and other requirements for second home refinances

A few other factors make refinancing a vacation home different than refinancing a primary residence.

First, while some mortgage programs are available for people with poor or little credit, you’ll likely need a good credit score to refinance a vacation home. Lenders may also require you to have at least 10% equity in the home — a loan-to-value ratio (the amount you hope to borrow vs. the appraised value of the property) of at least 90%.

Generally speaking, the lender will ask you to show at least two months of reserves for your vacation home — meaning you have the money in the bank to pay your mortgage for two months if you were to lose your job or face another financial hardship. If your payment is $1,000 per month, for example, you’ll need to prove you have at least $2,000 in the bank.

Pros and cons of refinancing a vacation home

As with every financial decision, refinancing a vacation home has benefits and drawbacks.

Pros

• Take advantage of lower interest rates. With a lower interest rate, you can enjoy lower monthly payments. This can free up cash and leave you with more money to pay off debt, save, or make home improvements to your vacation home.
• Reduce the long-term cost of the mortgage. If you’re able to land a lower interest rate, more of your payments will go toward paying off the principal. You may save thousands of dollars over the life of your mortgage. But if you refinance into a longer term — to a 30-year mortgage from a 15-year mortgage, for example — your total loan cost will likely increase.
• Get cash out. As long as you have equity in your vacation home, you can opt for a cash-out refinance. You’ll replace your current mortgage with a new one for more than you owe on your house. You can put the difference toward other financial goals.

Cons

• May increase your mortgage payment. If you take out cash or refinance to a longer term, your mortgage payment will likely go up. A larger payment may make it difficult for you to pay other bills and meet your financial goals.
• Can be difficult to qualify for. Most lenders who offer vacation home refinancing require higher a minimum credit score. If you don’t have the best credit score, you may not get approved for a refinance.
• Closing costs may be expensive. Refinancing fees and closing costs can add up very quickly. That’s why it’s a good idea to do the math and make sure you’ll save money with a refinance.