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A second home can serve many purposes, from a vacation destination to student housing for your children. Here’s how to know if you can afford to buy one.
There are plenty of reasons you may want to buy a second home. Maybe you’d like a second property for a family member to live in (e.g., your daughter while she attends university) or a condo to stay in during the week when you’re working downtown. But can you afford it?
“Before you buy a second home, you want to figure out what you’re trying to achieve—your goals and objectives,” says D’Arcy Henneberry, president of online mortgage brokerage MortgagePal.
Each lender has its own mortgage qualifying criteria, including how they look at your income and debt obligations, he says, so your first step should be speaking to a mortgage broker or financial advisor about your needs and financial situation.
That said, when it comes to affording a second home, here are the general rules and requirements to keep in mind.
Before you decide to buy a second home, there are several things to consider. Note that a second home is one that you or a relative will occupy; the rules can differ for rental or investment properties that you will not occupy.
“It’s important that you’re able to budget appropriately for the cost of the home. It needs to make sense,” says Henneberry. “You need to understand the costs associated with the second home, and if it fits within your budget, based on your income.”
Having a steady income (from, say, a full-time job) can help with getting approved for a mortgage, but it isn’t always necessary, Henneberry says.
Individuals who are self-employed or on contract can be eligible for second-home mortgage financing, as long as they have “confirmable income,” for example, from pay stubs or a notice of assessment from the Canada Revenue Agency. For individuals whose income fluctuates, some lenders will use their average income from the last two years. What matters is having proof of enough income to cover mortgage carrying costs.
“Affording a mortgage doesn’t mean you qualify for a mortgage. And qualifying for a mortgage doesn’t mean you can afford a mortgage,” says Henneberry. “We have a number of clients who are multi-million-dollar net-worth clients who don’t qualify for a mortgage, because they don’t have any cash flow that’s usable from an income perspective for mortgage financing.”
If a prospective buyer needs help to figure out what works for their budget, Henneberry says they should “meet with a trusted mortgage broker or financial planner to have a discussion around whether or not the second home makes financial sense for them.”
Before buying a second home, you want to get your financial house in order. That means reviewing your personal finances and seeing if you can truly afford it.
If you have a lot of high-interest debt, brokers may suggest you focus on paying that off first, as it may hinder your ability to make the mortgage payments on a second home.
But prioritizing debt repayment is not always the best option, says Henneberry. Instead, he recommends clients save as much cash as they can; then, when it comes time to apply for a mortgage, they can allocate that money either towards paying off debt or towards the down payment—whichever will help their application the most.
“Paying off debt first might actually stop you from being able to get the property, because you’ve used all your money and don’t have the money for the down payment,” he says.
There are many different ways to save for a down payment, and with second homes, a common source of funds is the equity in a buyer’s current home.
If you plan to use the equity in your primary residence for the down payment, you’ll first have to make sure you have built up enough equity, says Henneberry. There are various ways to borrow against the equity in your current home, but regardless of the option you choose, you will need to have more than 20% equity in the property. If you aren’t there yet, you’ll have to continue building equity, because you can’t borrow more than 80% of the value of your current home.
As with first-home purchases, if you wish to borrow funds to buy a second home, you will have to meet certain requirements.
The down-payment requirements for a second home are the same as those for a primary residence, as long as you will be occupying the home at some point during the year.
For homes valued at less than $500,000, you can put down as little as 5%. Homes valued between $500,000 and $1 million require a down payment of 5% on the first $500,000 and 10% on the portion above that. If the home is valued at $1 million or more, you’re required to put at least 20% down.
Note that if you will not be occupying the second property, you will have to meet different down payment requirements.
Whether you are buying a first or second home, most lenders apply mortgage debt ratios in their calculations to determine how much money you can borrow. Generally, lenders limit you to a gross debt service (GDS) ratio of 39% and a total debt service (TDS) ratio of 44%. Henneberry notes some lenders use different limits, but TDS (which includes your non-mortgage debt payments) is generally 5% higher than GDS.
Second-home mortgage applicants must also pass the mortgage stress test if they hope to get a mortgage from a prime lender, like a major bank. The stress test reduces the amount buyers can borrow for their mortgage by imposing a minimum qualifying rate. This helps ensure you’ll be able to make your mortgage payments if interest rates go up.
Typically, the credit score rules used for primary residences also apply for second homes, says Henneberry. It’s possible to get a mortgage for a second home if you have a credit score under 600. However, if you hope to get the most competitive mortgage rates, you want to aim for a credit score of at least 680 to 720, to be on the safe side.
If you’re putting less than 20% down on the property, your mortgage will have a maximum amortization of 25 years. However, if you’re putting 20% or more down on the property, you may have the choice of getting a 30-year mortgage.
Some lenders will include rental income from a secondary suite or basement apartment within the primary home in their debt ratio calculations, says Henneberry.
To be eligible, the rented portion of the home must be a separate unit, with a separate entrance, kitchen and bathroom. And, according to Henneberry, most lenders will only include 50% of the rent as income in their calculations; in these cases, the rental income is added to your total income.
While many home-buying programs, such as the Home Buyers’ Plan, are geared towards first-time home buyers, under certain circumstances they can be used a second time—after a set number of years have passed, for example. Land transfer tax rebates, however, can only be claimed once in your lifetime.
Before buying another property, it’s important to have a solid financial plan. If you’re considering buying a second home, first speak to a mortgage broker or financial advisor about your options to see if it makes sense.
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