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Buying a second home costs a lot of money. How much money it costs depends on where in the country you want to buy a new home. If you are looking to buy a second home in San Francisco or New York, you are likely going to need a million or more. If you want to buy a home in a smaller city with lower house prices, then you might be able to buy a second home for less than $200 000.
There are two main ways to finance the purchase of a second home. Either you can use your savings, or you can use a loan to buy the property. Both options have benefits and drawbacks. I generally recommend that you use a credit to buy the property even if you got the money to buy the house without a loan. You will find out why further down in the article.
Using a loan
Property is generally considered excellent security for loans and banks are usually willing to lend you money against security in a property. The loans will have low-interest rates compared to other types of loans. The reason for this is that the risk for the bank is very low. They know that they will get their money back one way or another.
You can usually not borrow 100% of the value of the house. You will have to provide a 100% down payment. In some cases, the bank might ask for a more substantial down payment. It is often possible to take out a personal loan to pay the down payment. The personal loan will have a higher interest rate. You might not be able to get a personal loan if you already have a lot of debt.
The cost of capital for buying a second home using a loan can at the moment be kept below 5%. If you have a good credit rating you might be able to get the cost down to or below 3%.
You need to have a good credit history to be able to finance a second home this way. You will also need an income that is high enough for you to be able to get approved for a loan. Let the bank know if your employer is going to pay you rent for you to live in the house or if you plan to turn it into an income property. Both these factors affect your ability to pay your monthly loan payments.
Using your own money
If you have enough money saved to be able to buy the house using your own money, then it can seem like a good idea to do so. If you use your own money then you do not have to pay any interest on a loan, and you do not risk losing the house if you are unable to make a payment. This is true but using your own money to pay for the house is associated with other costs. Costs that often can be higher than the cost of a loan.
If you use your own money to buy a house then you can not use the money to buy anything else. This will limit your future options. You might not be able to benefit from future opportunities since you no longer have the money to do so. If you borrow money to be able to benefit from the future opportunity then you might have to pay a higher interest rate than what you would have paid if you would have borrowed the money when you bought the house instead. In many cases, you might not be able to borrow the money at all and is unable to benefit from the future opportunity. Using your own money will, in other words, limit your future options.
Using your own money to buy a second home is seldom free. It is usually a lot more expensive than it is to take out a loan. If you keep your money and invest in the stock market (or other relatively low-risk investments ) then you will earn a return on that investment. It is easy to make more than 10% a year investing in high-quality dividend stocks. There are a number of high-quality companies that pay more than 5% yearly dividend (on top of that you will earn money due to the appreciation of the stock market value of the stock.). If you buy the house using your money then you will not be able to invest your money like this and you will lose this return. This is the hidden cost of using your own money to buy a second home.
Loan VS savings
It is easy to calculate whether it is cheaper to borrow money or if it is cheaper to use your own money to buy a second home.
If your money is currently invested, then you should check how much money the investment returns each year. Included dividends and appreciation. This number should be easy to find. Calculate the average value over the last few years if the investment is old enough to do that.
If your money is currently not invested then you should investigate how much you can earn investing in low-risk dividend and blue-chip stocks, The average yearly return on the stock market during the last 100 years is 12.25%. This can be used to calculate which option is cheaper.
Once you know the cost of using your own money you should contact a number of banks to see how much it would cost to borrow the money. Right now you are most likely going to pay less than 5% in interest rate on your loan.
12.25% is more than 5%. It is cheaper to borrow the money than it is to use your own money. Let us say that you buy a house for 100 000.
If you borrow the money, then you will have to pay 5 000 a year in interest to the bank.
BUT
You invested your money in stock and earned a 12.25% return on your investment (The average return as stated above). 12.25% on 100 000 is 12 250.
You earned 12 250 from your stock and paid 5 000 in interest. You are 7 250 richer at the end of each year then you would have been if you used your own money to buy the house.
It is always better to borrow the money than to use your own money if you can get a return on your money that is higher than the interest rate of the loan.