Whether it’s a cottage at the beach, a cabin in the mountains, or a condo in a bustling downtown, a second home is an appealing option for many people.
However, homeownership is a big decision, and owning two properties is (at least) twice as complicated as owning one. That’s why you need to understand what’s involved, the resources you’ll need, and how the decision may impact your financial future.
There are three main types of second homes:
- Vacation and weekend getaways
- Rental properties
- A house where you plan to retire
These categories can overlap: You may vacation in the house where you’ll retire or rent out your vacation home. Whatever your plan is, your intended use should play a significant role in your decision-making.
There are unique considerations for each type of second home, as well as questions you will need to answer that are common to all three.
The vacation getaway
If your dream is to own a vacation home, you may already have a location in mind. Chances are it’s in an area where people vacation! It’s not surprising that half of all second homes are in eight states, and that the top state — Florida — accounts for 15% of the total.
From a financial perspective, this is good and bad. Real estate in highly desirable areas is expensive, which could price you out of the market. On the flip side, if you can afford it, owning property in a vacation hot-spot increases the likelihood that your house will hold its value, if not appreciate.
Be honest about how many weeks you’ll be in the house in any given year. Does the time justify the expense, or would you be better off renting? If you plan to rent it out when you’re not there, is there a market in the off-season? Will you maintain the property yourself? How far away is it from your permanent residence?
If you’re not familiar with the area, spend a few vacations renting before you even consider buying, including in the off-season. You may discover this is more of a fling than a long-term relationship.
And remember that owning this home may cut down on your ability to vacation elsewhere — an important consideration if you’re someone who likes to travel.
The investment property
If you’ve seen TV shows about flipping houses or investing in real estate, you know that it’s easy money, right?
The truth is, while it’s possible to make money in real estate, it’s anything but easy.
First, you’ll need to assess the rental market in the location you’re considering. What is the demand for the type of property you can afford? Are the rental rates sufficient to cover your costs, which include not only your mortgage but also taxes, association fees, utilities, and homeowner’s insurance? Factor in these costs before you buy.
Understand what it means to be a landlord. Not only are you on call 24/7 when the roof leaks or the furnace breaks down, but it’s also your responsibility to find reliable tenants, hopefully with little downtime between rentals. Learn about landlord/tenant rights, which differ by state. You could choose to hand those duties over to a management company, but that will cut into what may be a slim profit margin.
On the positive side, there are tax advantages for real estate investors that can play into your favor. Remember that tax laws change and are complicated and getting professional guidance may pay off in maximizing your benefits and avoiding problems.
Finally, decide what kind of “investment” you are after: Will your profit come from buying and selling often, or will you hold on to a property long-term for a regular, monthly income stream?
The retirement property
Maybe you’re starting to think about retirement and you’d like to spend those years in a new place. Are there advantages to buying a retirement home while you’re still working?
The short answer: yes. You’ll have an easier time getting approved — and securing the best rate — while you’re still drawing an income. The Equal Credit Opportunity Act makes it illegal for lenders to discriminate against retirees, but they can consider your income.
Purchasing your retirement home while you’re still working also gives you the chance to get to know the area better. And you won’t have to dip into your retirement funds for upgrades and maintenance. Depending on when you buy it, you’ll build equity in your second home that could come in handy later or turn into an asset for your children.
Some advisors recommend buying your retirement home only when you’ve paid off your existing mortgage. That’s undoubtedly the best scenario. If the option is to carry two mortgages, be sure that’s a cost you can absorb. You don’t want to impact your financial plan negatively, especially your retirement savings. What good is a great retirement home if you don’t have the money to enjoy it?
As with vacation homes, know the location. After all, this is where you’ll spend many years, with a lot of free time. If it’s a place you regularly visit in summer, experience it in winter. You don’t want to be surprised when it’s too late to do anything about it.
And common to all three
Here are some things you need to consider, regardless of how you’ll use your second home:
- It may be more difficult to qualify. Lenders will look at your debt-to-income ratio: the ratio of your debts compared to your income. Most lenders require a DTI of 36% or lower, so determine if your mortgage payments put you over that threshold.
- Lending rates will be higher. This is especially true for investment properties, with the assumption that the transaction includes higher risk: It’s easier for borrowers to walk away from a failed business venture than it is from their own homes.
- You’ll need furniture and housewares. Enough said, but a cost that many people don’t factor in.
- Houses need regular maintenance. As an existing homeowner, you already know this. But you may not know what it’s like to care for a property that you don’t live in, that may be hours away, and that other people are living in.
As you dig deeper into the details of second homeownership, don’t lose sight of your original dream. If the numbers add up, a second home can provide decades of family gathering memories, additional income, or a place to enjoy your well-deserved retirement. The more you know now, the better the chances that your dream will become a reality.
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