Use asset method to determine what you can afford for second home

Thinking about buying that cabin in the woods you enjoyed over the weekend? Here’s one way to determine how much cash you can afford to put toward a second residence solely for your personal use or part-time rental.

It’s called the asset method. Start by taking stock of your present wealth. Create a balance sheet of your assets and liabilities. Don’t forget to include the equity in your primary residence, even though you may be dead set against borrowing against the roof over your head. Homes are no longer cumbersome and difficult-to-liquefy assets, thanks to the integration of home equity lending with other financial op- portunities.

If you have refinanced your home recently or have children needing loans for college, you are familiar with filling out forms provided by mortgage lenders and universities.

You know the drill — list all of your debts including credit cards, cars, boats, mortgages and anything else you view as a “minus” on your financial chart. Balance these against all of your assets, including your savings, individual retirement accounts, home value, stocks and bonds, and other assets. The net of these two numbers will give you your net worth and be an indication of the amount you have available to transfer into your investment.

Although it sounds simple and gives you a good ballpark number, the actual net number is more complicated. Some of your assets might be unavailable for reinvestment.

For example, if your retirement program does not have a loan program attached, those assets are tied up until you reach age 59½. Withdrawing retirement savings prematurely subjects the taxpayer to a 10 percent penalty, and the withdrawal amount is included in ordinary income for tax purposes. It would take a rather large rate of return to make the alternative investment worth the withdrawal. So to determine exactly what you have available for investment purposes, subtract those restricted retirement savings. What’s left is your capacity for acquiring investment real estate.