Are you considering buying a second home as a vacation home? You aren’t alone. Approximately 1.13 million vacation homes were sold in the US in 2014. Owning a vacation home can be wonderful investment of both money and time. The memories made at the beach with friends or skiing down a mountain slope with family will last a lifetime. However, buying a vacation home isn’t the right move for everyone. Here are five things to consider before making the plunge.
1. Can You Afford It?
This is an obvious question with some less than obvious considerations. Getting a mortgage on a second home is more difficult than getting one on a primary home. Mortgage companies often charge higher interest rates or require more money down on second homes. They also require a lower debt to income ratio and a very high credit score.
Even if you qualify for a loan, there are many other financial matters to think about. In a lot of cases, paying the mortgage payment is the least expensive part of the deal. If you are not prepared for these other expenses, you may have a rude awakening.
- Real estate is not a liquid investment. In other words, it has value but you can’t get at that value until you sell it. Depending upon the market, you may not be able to sell quickly. Plus, if you just recently bought the home, you may not even be able to break even. As long as you have other liquid assets, a vacation home might be a good addition to your portfolio.
- There are more costs than the purchase price. Other expenses include homeowners association fees, condo fees, property taxes, insurance, new furnishings, equipment to enjoy the area such as skis or a boat, maintenance, and management company should you choose to rent out your home. Nonetheless, many of these fees can be written off in taxes. Depending on your situation, your deductions may be enough to offset your expenses.
- Insurance is costly. Many vacation areas also have a higher risk of natural hazards such as flooding, hurricanes, or forest fires. This drives the cost of insurance up considerably. Not all areas have this issue. Check with a local insurance agency before you decide on a location.
- Do you have too much mortgage debt? If you have more than $1 million in mortgage debt, you will not be able to write off your vacation property mortgage. However, there are many loopholes to this law so speaking with a tax professional would be a good idea.
2. Where Should You Buy?
According to the National Association of Realtors (NAR), over 80% of those buying a vacation home choose one that is within driving distance of their first home. But there are other things to consider besides distance. Here are a few.
- Pick someplace that you will be able to enjoy for years.
- Visit an area several times before buying. You’ll want to be sure that it really suits you and all your needs.
- Consider whether the peak season is the same time you wish to spend time at your vacation home. If so, you will lose rental income and may find the area to be more crowded. However, if you love the area for its peak season activities, this may be the right spot for you.
3. How Often Will You Really Visit?
You need to be sure that you will be visiting your vacation home often enough to make it worthwhile. If you aren’t going to visit often, then renting something nice for vacation may be better for you. Here are some things to consider when purchasing to make sure you use your vacation home.
- Make it someplace you love to visit since you’ll be spending most of your free time there.
- Speaking of free time, also consider whether you really want to spend all of your vacation days in the same location each year. Having a vacation home means you are less likely to travel to other areas when you have time off. For those that love a particular climate or activity, this might be just what you are seeking.
- Finally, is the property located where others can take advantage when you can’t? Sometimes, a second home is a good deal if you know that you have family and friends that can also use the home.
If you do buy a home that will be unoccupied for long periods of time, you will want to be sure that you have someone looking after the home and making repairs as needed. Also, consider adding an alarm system and lights on timers. Keep in mind that if you don’t have a management service keeping up with your vacation home, you may find that your first several days visiting each vacation period will be spent in home maintenance and repairs.
4. Will You Rent Your Property When You Are Not Using It?
Many people buy a vacation home with the intent to rent it out to help pay for the mortgage. If you want to rent your property, you should consider the following.
- Choose a home that can be rented frequently enough and at a high enough price to cover the expenses.
- Make sure the community allows rental properties. Some communities with condo associations or homeowners associations have specific rules about renting. Some even require that you use specific management companies.
- Keep in mind the added costs for renting. These include advertising, cleaning between tenants, replacing broken or missing items, and property management fees, which can be as high as 50% of the rental amount.
5. Be Prepared to Talk to a Tax Professional
A second home can have a major impact on your taxes. Be sure to save all of your receipts and talk to a professional before the April 15th deadline. Here are a few things you will want to know.
- Mortgage interest and property taxes on a second home can be claimed as deductions.
- If your home is rented out less than 15 days a year, you do not have to report rental fees as income, but no other deductions are allowed.
- If you rent out more than 15 days a year, you will have to report income, but can deduct operating expenses such as utilities, repairs, insurance and management fees.
- If you sell your vacation home, all profits will be taxed as a capital gain.
- You may need to collect lodging taxes from your renters.