Mikey Rox and his husband, Everett Morrow, live full-time in New York City, but last year they also purchased a second house in Asbury Park, N.J., where they often spend their weekends.
It’s less than a mile from the beach, with three bedrooms and a private backyard—perks that are tough to come by in the Big Apple. “We wanted someplace we could relax outside of Manhattan,” says Rox, 33.
And when they’re not there, they rent it out. “We enjoy the idea of the house paying for itself,” Rox says.
Nationwide, hundreds of thousands of people just like Rox and Morrow are jumping on the vacation-home bandwagon. In fact, sales of second properties were up almost 30% in 2013 from the previous year, according to the National Association of Realtors.
But although buying a second home can be tremendously exciting, the decision also comes with its own unique financial considerations. So before you put an offer on that bungalow by the lake, consider asking yourself these eight key questions to help make sure your head’s in the right place.
1. How much will a second home cost?
We’re not just talking about the sale price here—there are a lot of associated expenses you should factor into the equation too. So while that vacation house you’ve been eyeing may be small, it still requires budgeting for a mortgage, property taxes, insurance, utilities and maintenance fees—and some of those expenses are probably higher than you think.
When you’re not living in a home on a daily basis, you often don’t have the ability to tackle small problems before they become big ones—and that can translate into higher maintenance costs in the long run, says David Blaylock, a CFP
® at LearnVest Planning Services. “Plus, you’re not on site. So a lot of the things you might normally take care of yourself, you’re going to have to hire someone to do.”
A good rule of thumb to consider? Consider budgeting about 1% of the home’s purchase price for annual maintenance. So if you bought a $300,000 home, set aside $3,000 a year for such common pop-up costs as an emergency plumbing repair or a new furnace. And if you have an older home that could present more issues or if you plan to rent it, you should aim for 1.25% to cover extra repairs.
And don’t forget to factor insurance into the equation. In general, insuring a vacation home will cost about 20% more than a primary residence, says Craig Venezia, author of “Buying a Second Home: Income, Getaway or Retirement.”
Insurance providers generally view vacation homes as a higher risk because you won’t be living there full-time. “In their eyes, there’s a greater chance the house can be damaged,” Venezia says. “And if you’ll be renting out the property, you’ll need additional medical and liability coverage in the event that one of your guests gets hurt on the property.”
2. Can you really, truly afford a second home?
Buying a second home is a money decision—not just a fun way to spend your leisure time—and it’s one you shouldn’t make until after the rest of your finances are in tip-top shape. Are you mostly debt-free? Are you saving enough for retirement? Do you have at least 20% equity in your primary residence, plus enough cash on hand for a 20% down payment and 3% closing costs for the vacation home? “You also want to consider making sure things like college savings are taken care of before you start evaluating the purchase of a vacation property,” Blaylock says.
And while mortgage approvals for second homes typically aren’t as stringent as they were a few years ago, lenders will still be looking closely at your debt-to-income ratio, which is how much money you have to pay each month for debts like student loans, compared to what you take home. Ultimately, Blaylock says, lenders want to know how capable you’ll be of paying back the loan in a timely manner.
In general, you should be able to accommodate all of your mortgage payments (including the vacation home) and the rest of your debt using no more than 36% of your monthly gross income. If you can’t make those numbers work, this probably isn’t the right time to spring for a vacation manse.
3. Are you buying it for the right reason?
Some people may view a vacation home as a cost
savings tool—they see it as a way to save on the lodging fees they’re paying every year when they take a trip.
But Blaylock warns against this strategy: “That’s pretty flawed logic—for the amount you’ll spend on a vacation home, you can take a lot of nice trips each year and stay in hotels.”
Another perspective? View it as an investment—either as a place where you plan to retire or a property that you can sell down the road to supplement your retirement income. When evaluating the investment property’s long-term potential, it’s important to research how prices have appreciated over time in the market where you’re buying.
“I suggest looking at median home prices over the last ten years,” Venezia says. “While this is no guarantee of how it will appreciate in the future, it will give you a sense of how it has performed historically.”
4. How do you plan to use the home?
Are you reserving the property exclusively as a second home for yourself, or will you rent it out to help cover associated costs? “Definitely think about why you want to buy it and how you want to use it,” says Venezia. “This gives you a basis to start thinking about types of properties and where to look.”
If you’re buying the house for your own personal use, you’re free to purchase whatever strikes your fancy—and disregard what might attract tenants. But if you’re counting on rental income to cover the mortgage, you should be more conscious of the home’s location and appeal to others. “For example, you may prefer that secluded cabin in the mountains,” Venezia says, “but many potential renters may find it to be too remote to rent.”
Also keep in mind that very different tax rules apply, according to whether your second home is for personal use or if you rent it. Given the complexity of tax considerations and reporting rental income, make sure to consult with a tax professional before you make up your mind.
5. If you do rent the home, is it the right property?
The first step is to think about how often you’ll want to rent, plus how long the potential rental season will be. “On average, people who are actively renting are doing so about 15 weeks out of the year,” says Eric Horndahl of vacation rental site FlipKey.com. “And they report, on average, that they make approximately $26,000 per year doing so.”
After marketing costs, that’s enough to cover the mortgage, taxes and insurance on the average $360,000 home—if you put 20% down, Horndahl adds. For some perspective, the median vacation home purchase price in 2013 was $168,700, and the median down payment was 30%, according to the NAR.
While you’re vacation-home shopping, take a look at similar properties in your area on FlipKey.com or HomeAway.com to see how active the rental market is, and how other places are priced on a nightly or weekly basis. “This can help prospective rental owners make assumptions on how many nights or weeks they will rent it out for, and project their rental income,” Horndahl says.
Next, consider how attractive the home will be to potential renters: Is it close to local attractions, such as the beach or a vibrant downtown? Does the property have any unique selling points or great amenities?
Buying your first home is likely to be the biggest investment you will ever make. The process can be daunting, particularly for first time buyers, but with the right preparation – buying property can be just that little bit easier. Here are our tips on how to be well prepared when buying a property.
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