Are you in the market for buying a second home? You probably have lots of questions — what’s it like to qualify for a mortgage on a second home, and are there still tax advantages? Let’s take a look.
Mortgage risk. Since lenders view second homes as being a higher risk for default than first homes, a mortgage company will limit your combined total mortgage payments to no more than 28 percent of your monthly gross income. Your total debt-to-income ratio cannot exceed 36 percent. Even if you intend to rent out either the first or second home, the rental revenue does not count toward raising your total income. Many lenders also will charge you higher interest rates on the loan for a second home, particularly if it is to be a rental investment property.
Tax implications. If the lending demands don’t scare you away, you may have second thoughts with the news on tax reform. As long as you use the home as a residence and not a rental for longer than 14 days in the year, nearly the same tax rules apply for second homes. However, the Tax Reform Act of 2017 lowers the maximum combined mortgage debt from $1 million to $750,000 for which interest is deductible. The original $1 million cap will remain in effect for homes purchased before December 15, 2017. The new law also limits the combined deduction for state and local income and property taxes at $10,000. The good news is that the rules regarding the payment of capital gains tax upon the sale of a second home remain the same. If you sell your home at a profit, you continue to be eligible to exclude $250,000 in gains if you are single, and $500,000 in gains if you file jointly.
When the home is a true rental. If you rent out your second home for more than 14 days per year, it is considered a business. You must report the income and pay income taxes, but more deductions become available from your federal tax return. Besides being able to deduct the mortgage interest and property taxes, you now can claim the expenses of the property, such as utilities, insurance premiums, fees paid to a property manager, and 50 percent depreciation. You may be able to deduct up to $25,000 in losses.
It’s always wise to consult your tax professional before purchasing a second home. Discuss your ideas and have he or she explain how your personal financial picture will change.