Owning a second home might just be the ultimate American dream. Taking on a second home mortgage is not. Don't let your dream of a quintessential Maine cottage or an upscale Vail ski chalet turn into a financial nightmare.
It's easy to fall in love with the idea of a vacation home. However, a second home is a major commitment. How do you know if you're ready? Here are four questions to ask before you buy.
1. Can You Afford It?
A second home mortgage might cost you more than you think. While mortgage rates are low, the other expenses haven't disappeared since the last time you bought a home. VA, USDA or FHA loans are not available for second homes and investment properties (unless your seller has one you can assume). Also, underwriting requirements for second home mortgages are generally stricter than those for primary residences. It's important for you to calculate the costs that accompany a home purchase upfront — points, fees, attorneys, inspections, and taxes.
Don't forget that you are going to have to furnish this place. And, you'll heat it and cool it and get the driveway plowed and the trash taken out. You have to insure it and maintain it. Once you have a good idea of all the costs that go along with second home ownership, create a realistic budget. You may want to do this with your tax professional or financial adviser. Only then will you know if you can really afford a second home.
2. To Rent or Not to Rent?
Airbnb is turning many second home owners into defacto innkeepers. Unless you plan to be there most weekends and vacations, renting your home out can be a wise way to ameliorate the costs of your second home mortgage. However, you'll want to consult a tax pro -- if you use your second home at least 14 days, you'll write off the second home mortgage interest on your Schedule A. If you want to treat it as a rental for tax purposes, you'll write off the interest, depreciation and other expenses (management fees, maintenance, and even furniture purchases) on a Schedule E -- but you won't be able to use it more than 14 days a year yourself (or more than ten percent of the total number of days it's rented out, whichever is longer).
This equation gets trickier if you are relying on your rental income to afford your second home mortgage -- you'll have to apply for an investment property mortgage, which will almost certainly have a higher rate. The appraiser will determine the fair rent for the property, and the underwriter will (usually) count 75 percent of that as income to you.
Keep in mind that even in the best market, weather or cancellations may dip into your expected income. The best way to hedge this bet is to do your research beforehand. Find out the rental vacancies rates for the area. Research the rental incomes and rental histories of comparable houses. Your real estate agent should be able to find this information for you quickly. In addition, may lenders require applicants for investment property mortgages to have two-to-six months of reserves (savings that can be used to make your mortgage payment even if there is no income that month).
3. Should You Invest in a Second Home or the Stock Market?
You should look at the purchase of a second home as a financial investment as well as an emotional one. Real estate does have some major advantages -- it can be leveraged (you only have to put up a fraction of the purchase price), there are major tax advantages (check with a pro), and it's historically more stable and predictable than stocks.
There are all kinds of online tools to evaluate real estate investments -- from simple to convoluted. Here are the inputs and results for a beach condo earning an average of $500 a month in rental income on one calculator.
4. Is This a Crush or Are You Really in Love?
You need to ask yourself how healthy will your relationship with your second home be?
- Will you be happy going back to the same place to vacation after vacation, year after year? Taking on a second home mortgage might mean you can't travel to other places as often or at all. However, if the property is in high demand, you could possibly rent it out and use the income to travel elsewhere.
- You will be dealing the upkeep and maintenance of your second home, potentially from a distance. Is the home in good shape or will you be constantly working (or worse, paying) to repair it?
- Is this the kind of home that will hold its value over the years? For example, waterfront properties are generally a very sound investment. However, if you get even a mile away from the shoreline and it can be a very different story.
A Second Look
If you decide to purchase a second home or vacation rental, your next steps are shopping for your mortgage (on LoanExplorer, check + More Options and choose second home or investment from the drop-down list) and getting preapproved for your loan (including your free credit score). Then it's time to call up the real estate agent.