Is second home a dream or a nightmare?
Second homes give people the chance to live another lifestyle, in another part of the country or even outside the United States. For some, it’s appealing enough to get another mortgage or invest a substantial amount of savings to buy one.
If you’re pining for a home away from home, you’re not alone. There were 7.4 million second homes in 2016, or about 5.6% of the total housing stock, according to a report from the National Association of Home Builders. The most popular place for a second home is Florida (1.1 million). California, New York, Texas, Michigan, North Carolina, Arizona and Pennsylvania are also popular states for second homes.
But before you join the club, make sure you’re prepared for the long-term responsibilities a second home comes with.
Consider the full financial impact.
As a (second-home) homeowner, all the financial responsibility falls on your shoulders — twice. If you have a sewer pipe problem in your main residence and then, a short time later, your HVAC system needs repair in your second home, you’ll have two whopping, back-toback bills.
Additionally, you’ll have double the bills for home insurance, taxes and various other expenses like utility bills, lawn maintenance and homeowners association, or HOA fees (when applicable).
“It’s very important that buyers write out a detailed budget, taking into account contingent expenses — for example, will flood insurance be required and what is that cost? Are the appliances going to need to be replaced soon?” says Charles Nilsen, national director of private client lending at Boston Private.
Although homebuyers might be able to afford these costs, keep your bigpicture goals in sight, says Daniel R. Hill, president of investment advisory firm D.R. Hill Wealth Strategies LLC, in Richmond, Virginia.
Hill encourages his clients to consider these bigmoney issues before jumping into another home:
Are you saving at least 15% of your current income for retirement? Do you have at least six months in an emergency cash fund readily available? Are you out of credit card debt? Is your current home paid off?
And, if applicable, have you established a college fund for your children?
If all of these boxes can be checked, then buyers are likely in a safe position to consider a vacation home, Hill says. Your ability to travel to other destinations might be squeezed.
The old saying “familiarity breeds contempt” can be applied to vacation homes, for some folks.
After 10 summers in Clearwater Beach, the appeal of warm Gulf waters might give way to the annoyance (and cost) of hurricane season. Likewise, a 10-hour scenic drive to a mountain cabin can quickly transform into a burdensome schlep after a few years.
The point is: Do you want to get stuck in one place for the long term?
“Buyers should consider whether the second home will compromise their ability to travel to other places. If the individual or family enjoys traveling to the same location each year, purchasing a home there may make sense, but it may be challenging to juggle the expenses of a second home with trips to other locales,” says Nilsen.
Renting out your second home
Collecting rent money can be a smart way to subsidize your vacation property. However, there are laws that you should be aware of before you buy. Keep in mind, laws vary by state, city and even neighborhood — so what’s good for one community, might not be allowed in another.
For example, in New York City, Airbnb is illegal unless the permanent resident is living in the apartment or the apartment is being rented out for more than 30 days. For condominiums, buyers should find out if the condo bylaws allow for renters or Airbnblike rentals. The same goes for HOA rules.
“Some communities require a minimum of 90-day rentals with prior association approval of the renter. If that’s the case, buyers will want to assess whether finding qualified renters will require a Realtor and calculate the commissions that will need to be deducted,” Nilsen says.
Cleaning services, insurance and general maintenance are costs landlords should include in their budget, as well. Since you can’t guarantee rental income, make sure you can afford these costs (including a monthly mortgage payment) on your own.
You might also have to forgo your desired time to be in your second home, in order to get rental income, which could diminish the appeal of a second home.
Taxes on vacation homes
According to the IRS, a vacation home is classified as either a personal residence or a rental property. It’s a personal residence if you limit renting it out to 14 days or fewer per year; more than 14 days and it’s considered rental property. In most cases, you’ll have to report rental income regardless of the classification.
If your vacation home is classified as a rental property, you won’t be able to claim the mortgage interest tax deduction. However, you can claim losses on your rental if the amount you spend exceeds your rental income. You can report these losses on Schedule E of your Form 1040.
Be sure to talk to an experienced tax professional about your potential liabilities and deductions. And keep in mind you can only deduct interest paid on mortgages of $750,000 or less total of all your homes.
Second homes can be a dicey investment.
Anyone who remembers the housing crisis knows that home values are not guaranteed. After the housing market peaked in 2006, values plummeted by 33% nationally, wiping out equity and forcing homeowners into foreclosure.
Many experts agree that residential real estate is not necessarily the best way to invest money, so for folks who want to build wealth buying another home might not be fertile ground.
“Many people mistakenly believe that real estate is a good and safe investment,” says Robert R. Johnson, professor of finance, Heider College of Business, Creighton University. “They fall prey to stories of real estate values rising dramatically over long periods of time. What they don’t realize is that from 1890 to 1990 the inflationadjusted appreciation in U.S. housing was just about zero. That amazes people, but it shouldn’t be so amazing because the cost of construction and labor has been going down.”
From taxes to renting it out, there are some important real-life considerations to weigh before buying that dream-life vacation home.