Considerations When Buying A Second Home
By: Kyle Ferrare, CFP®, CAIA
Summertime is here at last! If you haven’t made plans already, there’s a good chance you’re thinking about where you’d like to spend the warmer months this year.
You might even be thinking about purchasing a vacation home. Despite it currently being a sellers’ market, the ongoing low interest rate environment is appealing to buyers. But does buying a second home make sense for your family? There are a number of different factors to consider as you think about this question.
Personal and Family Benefits
There are personal and relational benefits to purchasing a second home. In speaking with Managing Partner Joe Belfatto, he says “The vacation home we purchased in Bay Head, New Jersey 20 years ago has become my family’s ‘happy place.’ It’s where we go when we are looking to disconnect, recharge, and spend time with friends.” As your children get older, they will disperse to attend college and launch careers of their own. A vacation home provides an attractive place for them to return to and re-connect with family – and later down the line bring along children of their own.
You’ll need to think carefully about location, will your new home be easy to get to? Or does it require air travel? Typically vacation homes that are conveniently located get the most use and make it easy for friends and family to visit. If you have kids, consider what boundaries you want to set around use of the home. Will you allow your kids to use it when you aren’t there? If so, what ground rules would you put in place? When you are thoughtful about this process, the right vacation home can become a treasured place where you and your family create memories and build traditions.
Taking on the Financial Commitment
Perhaps the biggest factor is the financial commitment you’ll be taking on. Depending on where it’s located, a second home could cost just as much as your primary residence. Other expenses like insurance, utilities, repairs, maintenance, property taxes and association fees will drive the cost of ownership even higher — maybe even higher than your primary residence.
Your vacation preferences are another key factor. If you have a passion for travel and like to discover new destinations every year, then buying a second home might not be right for you. But if there’s a favorite vacation spot you go to regularly, buying a second home there could offer advantages. For example, you’ll guarantee that you have a place there whenever you want, at a fixed cost, and if you choose a vacation spot within driving distance your new home can become a weekend retreat for you to enjoy throughout the year.
Another benefit is that you can customize and design your second home so that it is uniquely yours. If you think you may want to live there full time one day, purchasing a second home now could make financial sense. Real estate often appreciates over time, so holding onto a second home for the long term might pay financial dividends if it becomes your primary residence when you retire.
Renting Out Your Second Home
Many families offset some of the cost of buying a vacation home by renting it out when they’re not staying in it. In fact, 42% of those buying a second home say they do so mainly to use the home as a short-term vacation rental, according to a survey by VRBO.[1]
But renting out a second home isn’t as easy as it sounds. There is a significant workload associated with renting out a property, including marketing it, cleaning it between guests and staying on top of maintenance and repairs. You’ll need to think carefully about whether or not you are prepared to manage these tasks or if that’s something you’d prefer to hire out.
Many vacation homeowners use a property manager to handle tasks like these. If you go this route, you’ll want to be sure that you can absorb the management costs and still rent out your home profitably. The industry standard property management fee for vacation rentals is from 25% to 30% of the rental cost, according to Lodgify.[2] So if you’re charging $1,500 a week for a mountain cabin, nearly a third of this — or $450 — could end up going to the property management company. Again, be sure to factor this into your analysis.
Also make sure you’re allowed to rent out your second home if you plan on using it for short term rentals. Some homeowner associations restrict property rentals — for example, by not allowing weekly rentals or requiring that you own the property for a minimum length of time (such as one year) before you can rent it.
Finally, keep in mind that there are tax implications involved in renting a second home. If you rent the home for more than two weeks out of the year, you must report the rental income on your tax return. If you live in the home at least two weeks a year or for 10% of the days it’s rented out, the home will be considered a secondary residence instead of an investment property for income tax purposes. This means you can deduct the interest paid on up to $750,000 of mortgage debt, as well as property taxes paid (subject to SALT limitations).[3]
Financing a Vacation Home
Compared to financing the purchase of a primary home, obtaining a mortgage on a vacation home is subject to a high barrier of entry. Second home mortgages are generally harder to qualify for than a traditional primary residence mortgage, and they often involve higher interest rates and a larger down payment. You’ll have to demonstrate to the lender that your income can cover both the overhead on your primary residence and the second home mortgage.
Different lenders define second homes differently. Some will define a second home as an investment property if you plan to rent it out, even for just one or two weeks a year. Others allow limited rentals before classifying a second home as an investment property. If the home is considered an investment property, it will typically result in an even higher interest rate and down payment requirement compared to a second home mortgage.
How A Financial Advisor Can Help
A Simon Quick advisor can help you crunch the numbers and consider all the factors as you weigh the pros and cons of buying a second home. To learn more, call us at (973) 525-1000 or send an email to info@simonquickadvisors.com.
About Kyle Ferrare
Mr. Ferrare joined Simon Quick in 2011, and works directly with high net worth clients in developing and implementing their investment and financial planning goals. Based in Denver, CO, Mr. Ferrare also works with single family offices, endowments and foundations and regularly attends investment committee and board meetings. Prior to joining Simon Quick, Mr. Ferrare spent five years in the Private Client Advisor Practice at Deloitte Tax LLP. He provided tax advisory services to a variety of private clients including high net worth individuals, investment partnerships, corporate executives and owners of closely-held businesses. Mr. Ferrare graduated from Bryant University with a BS in Finance. He completed the Financial Planning Certificate Program at Fairleigh Dickinson University in December 2009 and became a CERTIFIED FINANCIAL PLANNER™ practitioner in November 2010. In April 2014, Mr. Ferrare became a Chartered Alternative Investment Analyst (CAIA). To learn more about Kyle visit his LinkedIn.
References
- [1] https://www.vrbo.com/media-center/press-releases/2019/vrbo-and-savills-release-global-research-on-second-homes
- [2] https://www.lodgify.com/guides/property-management/fees/
- [3] https://www.fool.com/millionacres/real-estate-investing/rental-properties/real-estate-101-heres-what-you-need-know-you-buy-vacation-home/
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