By David McMillin, Bankrate
If you're weighing the pros and cons of buying a vacation home, you're not alone. As of May 2020, second-home buyers and investors accounted for 14 percent of home sales, according to the National Association of Realtors. Before you move forward with plans to buy a vacation home, here are some of the major implications to consider.
Should I buy a vacation home?
The easy answer is yes - after
all, who wouldn't love the chance to own a place to escape the worries
of a regular routine, or an opportunity to turn a profit? However, there
are plenty of additional follow-up questions to address.
Can you really afford it?
Aside from making the
purchase upfront, a vacation home isn't a vacation away from the typical
costs of being a homeowner. It's important to ask yourself if you can
financially manage the added expenses of owning a vacation property.
"With
a second home comes additional annual property taxes," says Hayden
Adams, director of tax and financial planning at the Schwab Center for
Financial Research. "Beyond taxes, there will be insurance, maintenance
costs and potentially HOA fees or assessments for improvements if the
second home is a condo."
Insurance costs on a vacation home alone
can be quite high. According to the Insurance Information Institute,
insuring a second home can cost more than protecting your primary
residence, and the cost can vary depending on the location of the home
(and whether that necessitates coverage for flooding or other hazards),
the kind of property and whether there are features like a pool or spa.
If
you're thinking about buying a vacation home, though, chances are you
feel comfortable with your personal finances - but, a second home isn't
without risks. In a 2019 Federal Reserve Board working paper,
researcher Daniel Garc'ia points out that vacation property purchases
played a major role in the financial fallout of the late 2000s.
"Second-home
buyers were typically over-leveraged," Garc'ia writes, "and despite
having middle to high income and credit scores, experienced higher
default rates than average during the recession."
How much time will you be able to spend there?
Consider
your calendar. How much vacation time can you take advantage of in your
current work situation? If you can handle your job duties remotely,
perhaps the vacation home will serve as more than a weekend getaway
destination.
How long will it take you to get from your primary
residence to the vacation home? If you can hop in the car and arrive in a
few hours, that easy access will translate to plenty of use. If getting
there requires advance planning and airport hassles, the home may sit
empty more than you expect.
Who will look after the home when
you're not there? In addition to insuring the home, you may need to find
someone local who can check on the property to make sure that nothing
major - burst pipes, insect infestations or vandalism, for example - has
gone awry.
Will you rent it out?
There's another set of
considerations if you're buying a vacation home with the intent to rent
it out when you're not using it. Be sure to investigate local rental
laws and consider consulting with a real estate agent or attorney in the
area. With Airbnb increasingly popular, some lawmakers have restricted
short-term rentals in certain spots.
When rental activity is good,
the income from a tenant can help cover some of the extra costs of your
second home. However, Adams says that "there are a host of tax issues
with a rental property. For example, if you rent and make a profit, you
may need to pay ordinary income taxes and possibly the 3.8 percent net
investment income tax. If the rental property loses money, some owners
may qualify for a tax deduction, but these rules can be complex."
Also,
are you planning to eventually sell the property? If you do, Adams says
you may pay capital gains taxes, as well. He recommends consulting a
tax professional prior to buying a vacation rental home so you know what
you may be liable for.
Benefits to buying a vacation home
The
clear benefit to buying a vacation home is the ability to spend more of
your time in a place where you can unwind. Rather than paying to stay
in a hotel each time you visit, you'll enjoy the comforts of your own
abode.
Those comforts can create a profit engine, too. A 2019 survey
of more than 7,000 vacation homeowners who listed their property on
vacation rental site Vrbo revealed that about 40 percent used the rental
earnings as a source of secondary income.
Drawbacks of a vacation home
Spending
more time on vacation and collecting rental income are great perks, but
there are downsides to owning another piece of property, as well.
"People
tend to overestimate the income a rental property will generate and to
underestimate the costs and headaches of managing the property," Adams
says. "They may be surprised that the rental property ends up being a
net drag on their finances."
Additionally, while you may love the location of the home now, will it restrict your globetrotting adventures elsewhere?
"People
should consider the alternative costs to a second home," Adams says.
"Most people only have a limited amount of time off and may not want to
spend all that time at a vacation home. The funds used to purchase a
second home could be used to travel rather than pay for a second home."
Next steps: How to finance a vacation home
If
the pros outweigh the cons and you're ready to buy a vacation home,
it's time to think about the best approach to pay for the property.
Adams says that paying in all cash can be a good way to avoid interest costs, provided that making a huge payment doesn't affect your overall lifestyle.
"However,
a lot of people don't have the means to do an all-cash purchase and
trying to do so could leave them without a much-needed emergency fund,"
Adams says. "A mortgage can leave less of your cash tied up long-term,
which means those funds could be invested for potentially greater
returns."
If a mortgage is the better option for you, shop around for the best interest rates
you can find, as they'll likely be higher than the rate for the
mortgage on your primary residence. Look for a local lender in the area
you hope to buy in, as well - the company may specialize in second-home
financing and can recommend the best type of loan for your purchase.
See more at Bankrate
