I have been helping clients arrange mortgage financing for many years. I find that in the height of the summer or just after Christmas, clients will ask about buying a vacation home. They want to know how to finance a second home or vacation home.
In Canada, you can purchase a vacation home or second home with as little as 5% down. The qualifying criteria for second home financing is the same as for purchasing your first or next home. You must have good credit and have enough income to make the mortgage payments as well as cover all your other financial obligations.
There are a number of different options and choices regarding financing, depending on your situation, and I can go into more detail below.
- What are the qualifying criteria to finance a second home?
- Is vacation home financing the same as rental property financing?
- What are down payment requirements for a second home purchase?
- Three strategies to finance a second home
- Example of client who purchased a vacation home near ski resort
- Example of client who purchased a second home for his daughter to attend university
- Example of a client who purchased a second home for his aging parents
What are the qualifying criteria to finance a second home?
The qualification criteria for a second home purchase is the same as the criteria for purchasing your current home. Good credit is be a given, that is, a credit score above 650.
Standard qualifying criteria in Canada include the TDS and GDS calculations. TDS is the total debt service ratio. GDS is the gross Debt Service ratio. TDS is calculated using all of your payments divided by your income. GDS is calculated by using all of your payments for housing costs divided by your income.
When qualifying for a second home, lenders will use the TDS calculation. Lenders will calculate how much your total financial obligations are including your mortgage payments property taxes, all loan payments and credit card payments.
These payments will be divided by your income. As a guideline, the total payments you make can not exceed 44% of your income.
Because you are financing the purchase of a second home, lenders will not include rental income to offset any of the payments on the second home you are purchasing.
The TDS calculation is used to determine exactly how much mortgage you would qualify for based upon your income and your current monthly obligations including credit cards loans and other mortgages.
As a mortgage broker, I'm biased, but I would recommend speaking with a mortgage broker to see what you qualify for. When you go to your bank, they may or may not have programs available. They won't tell you about programs they don't offer. Your mortgage broker will have access to more options and programs and lenders.
Is vacation home financing the same as rental property financing?
There is a significant difference between financing a vacation home or a second residence and a rental property.
Rental property financing will have higher interest rates because the banks (lenders) perceive that the risk is higher for those types of properties. A rental property purchase will also require more down. Many banks want 25% down on your rental property purchase and some will allow up as little as 20% down.
To finance a vacation home or a second residence you can Finance with as little as 5% down. The interest rates for a second residence mortgage are at best rates. As long as you have good credit, you will get the best interest rates available.
The qualification process for second home financing cannot include rental income. The criteria for a second residence requires that you were a family member utilize the property for at least six months of the year. At 6 months does not have to include or be continuous, you can come and go.
What are down payment requirements for a second home purchase?
As mentioned earlier, 5% is the minimum down-payment to purchase a second residence or vacation home. This is an insured program. Meaning, there will be mortgage default Insurance added to the total mortgage amount. The mortgage default insurance is at the same premiums as if you were purchasing a principal residence.
You can finance with more down and many clients do. If you have 20% down or more to purchase a second residence then no default insurance is required.
As a side note, default insurance is required for all property purchases in Canada with less than 20% down.
Some properties that you may purchase as a vacation home, like a cabin or a home without all services (electrical, water, sewer, etc.) may require default Insurance regardless of the down payment.
Three strategies to finance a second home
There are three strategies that we have used to help clients to purchase a second home.
- Purchase with just 5% down, from savings, and finance the rest.
- Refinance your existing home to access 20% down (or more) then purchase.
- Refinance your existing home and pay cash for your vacation home or second residence.
Purchase with just 5% down, from savings, and finance the rest.
This is fairly straightforward. If you have cash 5% more to use towards the purchase of a vacation home then we can Finance the rest. There is a program with a few of the insurers to provide this type of financing. Qualification is as described above. You must have good credit and sufficient income to cover your current monthly credit obligations and the new mortgage including property taxes any applicable, property taxes and heating the property.
Refinance your existing home to access 20% down (or more) then purchase.
Some clients will have the cash saved for 20% or more down on the purchase of a second home. However, sometimes do not have the cash available but have lots of equity in their current residence.
In this case you can either set up a home equity line of credit behind your existing First Mortgage to access equity up to 80% of the value of your home. You could also refinance your current residence up to 80% of the value. Both options will get equity out and cash for you to put towards the down payment of your second home.
Financing in Canada for an existing residence is restricted to a maximum of 80% of the value of your home through OSFI governed lenders. This is getting a little technical but basically all the major banks in Canada Trust company's credit unions and many of the monoline lenders are covered under OSFI rules.
It is possible to finance up to 85% or 90% of the value of your home with a private lender however for the purchase of a second residence, private financing may not be the best option for you. Interest rates are higher and fees are higher. Unless you're getting a really good deal for the vacation home I would wait to save the 20% or utilize the 5% down program.
Refinance your existing home and pay cash for your vacation home or second residence.
If you've built up a lot of equity in your current residence then setting up a line of credit or mortgage using your present home could be an option. Most clients utilize this option if they're purchasing a vacation home outside of Canada.
A Canadian Bank cannot finance foreign properties. Let's say you want to purchase a home in Arizona. no Canadian Bank can finance a property in Arizona. However, you could arrange financing on your principal residence to get enough equity out to purchase your property in Arizona for cash.
Other clients will consider purchasing a property with a rental pool as a vacation home. That way, when they aren't using the property it can be a part of a rental pool and cover some of the costs that are associated with a second home. In this case it's difficult to finance rental pool properties with traditional lenders. We will generally arranged financing through your principal residence so that you can pay cash for the rental pool vacation home.
Let's look at some different situations where clients will purchase a vacation home and house financing works.
Example of a client who purchased a vacation home near ski resort
Last year I had a client who love to ski in Fernie. His family loved to ski. They traveled to different resorts, but Fernie was their favorite resort. They had been renting a place in Fernie for several years. They stayed over almost every weekend over during ski season. The real estate market changing in Fernie and they were given an opportunity to buy the home they rented.
This family had saved 10% of the purchase price and wanted to have the financing on the vacation property. They didn’t want to mix house expenses with their vacation home budget. We set up the financing for them with a lender that was offering very good interest rates.
They ended up paying a little more for the financing than they paid for rent, but almost half of the payment was going toward building equity. They ended up spending more summers in Fernie than they had before. They also had more friends a family visit and enjoy their place.
Example of a client who purchased a second home for his daughter to attend university
A few years ago, a client’s daughter was accepted to the education program at the University of Lethbridge. When they first traveled to Lethbridge to check out options for his daughter to live, he noticed that rent was quite high.
We reviewed options for him purchasing a home there for her to reside instead of renting. The purchase price at that time was very reasonable, he had 5% available for a down payment. He purchased the home under the second residence program. His daughter moved in September and had a friend as a roommate.
The cost for the property was close to the cost of her staying in Residence. After 4 years they had paid down the mortgage and she moved to Calgary for a new job. He sold the home for more than the original purchase price. After real estate and closing costs, he came out with a profit.
He raved about the second residence program. Effectively, his daughter went to school with no living expenses. that is, the profit covered all his out of pocket expenses for those four years.
Example of a client who purchased a second home for her aging parents
Recently, a client was talking to me about his aging parents who lived in Saskatchewan. They were having some health related issues and he and his wife were spending a lot of time traveling back and forth.
After chatting with his parents and reviewing financing options with me, he decided to purchase a home around the corner from where he lived. He used the second residence program to pay for this home with 5% down.
His aging parents sold their home in Saskatchewan and moved to the new property around the corner from them in Calgary.Now he and his wife can drop over and help them out whenever they need.
He had a small mortgage on his own home and could have financed his home to get the cash out to purchase. However, he wanted to keep the expenses for this home separate from his own property. He and his brother were helping out his parents and they were splitting some of the costs.
The second residence program is an excellent financing program for many different clients who need or want financing on a vacation home or a second property for a family member. There is lots of flexibility to the program and you get best mortgage rates, as long as you have good credit.
I've given a couple of examples here. He client purchasing a vacation home. The client purchasing a second property for his daughter to go to university. I've also shown an example of a client who purchased a home for his aging parents. There are many more examples that this program can be utilized for. There are also options if you wish to purchase a vacation home in another country.
I would recommend that you speak with a mortgage broker, or connect with us to get more details on how much you may qualify for.
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