Hopefully you are enjoying your summer, whether it is at the beach, in the mountains, in your backyard, or even sitting poolside enjoying your favorite beverage. This time of year makes it easy to fantasize about what retirement may look like – or even if you are retired – what life can look like away from “home”.
Vacations are great – everyone needs down time to recharge their batteries, reflect on the past, and look ahead to the future. Some people prefer to travel, while others would like a “home away from home”. At what point should you consider buying that vacation home or second home? In part of that decision making process, there are some questions you need to answer first:
Where's a good place to buy? Take a look a market demographics, re-sale prices, weather, proximity to grocery/shopping/medical centers, traffic, etc.
How will you get there? According to the National Association of Realtors (NAR) 1 , more than 80 percent of vacation-home buyers choose locations within driving distance of where they live, with about half of all owners opting for properties within 50 miles of their primary residence. Proximity to your home is especially important if you plan to visit the property frequently. Much as you loved your trip to Fiji, you're not likely to fly to the South Pacific for a three-day weekend.
Will you need rental income? NAR statistics show that most owners of vacation homes do not rent out their properties, but if you can't quite make the mortgage payments without some rental income, it's best to choose a popular destination where demand for short-term lodging is high. Experts say the most desirable spots are near oceans, lakes or rivers, or at mountain recreation areas.
Will the location suit your future lifestyle? Planning for long-term enjoyment can mean buying a place that's big enough for a growing family, or choosing an area with a range of recreational opportunities to accommodate evolving interests. Mountain biking may be your current obsession, but what happens if you decide to take up golf or fly-fishing? And if you're buying a home for future retirement, be sure to look for the kind of structure and location where seniors can live comfortably. Thirty years from now, will you want to climb stairs to reach the master bedroom, or drive a rutted dirt road to your rustic cabin in the woods?
Once you’ve answered those questions, you can move on to the important part – how am I going to pay for it?! Vacation-home buyers often make down payments of 20% to 50%. Some even pay cash if they're buying a less expensive cabin or condo. Apart from savings, an easy tool to finance this new mortgage may be a home-equity credit line drawn on your primary residence (obviously making sure you have enough equity in your house to cover it).
Higher interest rates used to be the rule for mortgages on second homes because lenders considered them a greater risk than loans on primary residences. But these days you may be able to find a second-home mortgage at first-home rates. (Exception: If you'll be counting on rent receipts to help pay the mortgage, the rates will probably be higher.) The bad news, is that burdened though you may be with two mortgages (or three, counting the home-equity line), lenders will expect you to stay within the debt-to-income limits dictated by Fannie Mae and Freddie Mac. Your total debt payments, including all mortgages, can't exceed 36% of your gross income. The good news is that if you plan to rent the place, you can count some of that assumed rent as income when calculating the ratio. The lender will tell you what's an acceptable assumption.
About 25% of vacation homes are rented to other people for part of the year, and the appeal of different kinds of properties vary with the seasons. For tax purposes, vacation homes are subject to what's called the 14-day or 10% rule. You can rent your place for up to 14 days a year and pocket the rental income without having to declare it on your tax return. If you rent out the house for more than 14 days a year, you are considered a landlord by the Internal Revenue Service and you must report the income.
In addition to any possible mortgage payment, you will need to estimate all of the carrying costs to own the property including (but not limited to): taxes, association fees, utility costs (phone, internet, electricity, water, sewer, etc.). You must also budget in normal costs to maintain the house for repairs and upgrades. Try to plan for the unexpected – what if you need a new roof, pipes bursting/clogging, windows, electrical, driveway, and one-time assessments if you are in an association, to name a few.
After you have worked out the financials, draft up a pro’s versus con’s list. Think about the psychological effects – will you worry when no one is there as to what is going on? What if there is a hurricane? What if renters (hopefully not your friends) trash the place?
In some instances, we have added up the costs for clients and it is cheaper for them to take a 2-3 week vacation annually (traveling all over the world) rather than pay for the cost of a vacation home. With that being said, there is also the psychological aspect of knowing that you own a vacation home to get to at any moment – and be there at retirement time! It is easy to make decisions based on emotion, but rather than regret them later, please use us as a sounding board and outside professional opinion. Until then – enjoy your summer – wherever it may take you!