With today’s current low interest rates, homeowners are looking to buy. But they’re not always looking to sell. According to the National Association of Realtors, more than 2 million vacation and investment properties were purchased nationwide last year.
Buying a second home comes with unique financial considerations. Before you purchase a vacation home or investment property, there are a few questions you should ask yourself and discuss with your financial adviser:
What’s your goal?
Will your new home be a true second home, or will it be a rental property for investment income? Your vision for the home will affect its total cost.
A couple I work with recently purchased a second home in Florida and plans to use it as a rental property for the next decade or so. When they retire, they plan to make it their full-time residence. Since the couple knows where they plan to settle down, they can get everything set up in advance and have the home’s mortgage covered by renting it out.
If you’re purchasing a second home as an investment property, you should work with a financial adviser to understand how it may compare to traditional investing. Real estate appreciation values are historically fairly low, so you should use a conservative growth rate and look at median home prices in the area over the last decade. These prices are not a guarantee of how a home will appreciate in the future, but can give you a sense of how it has performed historically.
Can you afford two mortgages?
Before buying a home, have a financial plan in place to understand your cash flow of income in and expenses out. It’s common to underestimate the costs of owning a home. You may have money for a down payment now, but how will a second home impact your savings over time?
If you’re purchasing a second home as an investment, work with a tax professional to understand the implications of short-term gains and non-primary residence sales. You should also plan ahead so that if a renter suddenly moves out, you will still be able to afford the property. Everyone should have an emergency fund to cover six months of expenses, but that means owners of second properties need to be able to cover two home mortgages for at least six months.
Can you afford the maintenance?
On top of the sale price, there are additional expenses you’ll need to plan for. Rental properties in particular may need a high number of repairs. When you’re not living in the property but it‘s being used, you don’t always have the ability to tackle problems before they become a larger issue.
The amount of money you’ll need to set aside for repairs depends on the cost of the home, the home’s age and renters. General maintenance costs include repairing and replacing appliances, but you should also be prepared to cover larger costs, too, in case renters damage the property and it goes beyond the savings deposit.
A general rule of thumb is to have two percent of the home’s sale price set aside for annual maintenance. And if you don’t want to answer phone calls at 1 a.m. about a leaking roof, you should add in budget for a property manager.
Another financial factor to consider is insurance since insurance costs on vacation properties typically run higher than insurance for a primary residence.
How will you finance it?
Today’s low interest rates make borrowing easier than in the past. However, lenders assume that second homes are more likely to default, so credit-score requirements are higher than for primary homes and you have to be able to show that you can carry both payments.
If you’re not looking to buy immediately, set aside investment savings now for the second property and work with your financial adviser to make sure that the savings have an appropriate investment allocation. If you’re buying now, use existing cash savings or, if possible, pull from a dedicated portfolio, but do not dip into your retirement savings.
David Mount is a senior vice president at the Wise Investor Group at Robert W. Baird & Co. in Reston, Va.