Vacation homes in the top 30 markets have risen in price by 120 percent in the past five years, nearly twice the increase for primary residences, according to Fiserv Lending Solutions. But more recently those markets have been cooling along with the national slowdown in residential sales, which may make this a good time to think about purchasing the second home you’ve always wanted.
Buying a vacation home is a significant financial commitment and can be complicated; that’s why it’s important to work with your financial advisor to see how a vacation home fits into your overall financial strategy and budget. Before you make an offer on a property, you need to consider a number of steps to make sure the purchase is right for you.
Location, Location, Location
The first step is deciding the setting for your vacation house. Are you looking for a quiet lakefront retreat? Or, is a ski chalet more suited to your active lifestyle? Second, you need to consider proximity to your primary residence. One-third of second homebuyers purchase a place within 100 miles of their primary residence, while another third venture more than 500 miles, according to the National Association of Realtors. Plan to visit the area several times before you make a commitment to buy.
After you have picked the perfect spot, you need to make sure you can afford properties in that market that suit your needs. Condos tend to be less expensive than detached homes and far easier to maintain. Depending on the type of condo, some lenders will require a larger down payment, as much as 20 percent to 25 percent of the purchase price. Mortgage interest rates also might be higher on a condo and you will most likely have to pay monthly condo association fees.
Know Your Budget and Funding Options
Housing costs for all of your homes should exceed no more than onethird of your total income. This includes all costs: mortgage, taxes, insurance, maintenance and any association fees.
A popular strategy for paying the down payment on a second home is through a cash-out refinancing of your primary residence. This approach might lower the interest rate and closing costs compared with a home equity loan. You can also speak to your advisor about borrowing the full value of the home or other financing options.
The affordability of a vacation home must also take into account the tax consequences. If you spend at least a few weeks out of the year living there in your vacation home, you and your spouse may be allowed to deduct mortgage interest on up to $1 million in debt on all of your residences.
You can also deduct interest payments for home equity loans and property taxes. But some restrictions on deducting mortgage interest apply if you rent the property and deductions may also be limited if you are subject to the Alternative Minimum Tax (AMT). It is a good idea to consult a tax advisor if you are considering buying a second home, particularly if you want to rent it.
Renting Out Your Vacation Home
If you plan to rent out your vacation home to help pay for it, be realistic about how often and how much you will rent it. The average vacation home is rented for 12 nights a year for 25 percent of the homeowners who choose to rent their properties, according to the National Association of Realtors. While your home might rent for a substantial sum, you might have to pay a management company as much as 50 percent of the rent to take care of renting, cleaning and maintaining the property.
Popular rental times, like holidays and school vacations, are often the same times that you might want to use the property. Also, know that your rental income must be reported on your tax return if your rent it out for more than two weeks during the tax year.
When you’re ready to buy your vacation home your financial advisor can help you work through all the details. From determining the size of your down payment to ensuring the rest of your personal and financial goals are secure, your financial advisor can help make buying your home away from home as simple and stress-free as possible.
Larry Washington is Chairman and CEO of Merrill Lynch Credit Corporation. Any information presented about tax considerations affecting your financial transactions or arrangements is not intended as tax advice and cannot be relied upon for the purpose of avoiding any tax penalties. Neither Merrill Lynch nor its Financial Advisors provide tax, accounting or legal advice. You should review any planned financial transactions or arrangement that may have tax, accounting or legal implications with your personal professional advisors.