The Vacation Home Primer: Pros and Cons
April 1, 2021The pandemic over the past year has been a challenge for everyone, and it may have you bursting at the seams for a vacation!
The new norm of remote work and lower interest rates may have inspired you to think about making your next spending spree on a second home in your favorite place. You would not be alone: sales of vacation homes rose 44% year-over-year in the three months ending September 2020, and 58% of those homes sold within one month1, which is faster than any time in recent history. With higher demand, vacation home prices have also risen 32%2.
Unsure about the pros and cons of making the leap for greener pastures? Here are some important considerations before purchasing your dream vacation home:
Owning vs. Renting: Nothing is worse than buying a property because it looks cool on paper and then realizing after you get there that the location fails to meet important objectives. It is therefore advisable to select a property in an area that you already know well. Then, do the math on how much time you want to be there. For example, it could be much more cost effective to rent versus own a vacation home if you only plan on spending a few months there or less. Also consider the total cost of ownership and operation of a second home. How much are you spending on items like property maintenance, utilities, real estate taxes, and property insurance? These are costs you will incur year-round even when you are not physically there.
Rental Income: The most obvious benefit of renting out your vacation home is you can earn extra income when you are not there, which helps pay for the property and creates another source of income. But be careful. The first determination to make before committing to a rental property is what are the rules. For example, some local government agencies or home ownership associations may restrict or charge fees for property rentals. Also, consider the additional costs and risks. You still must spend time and money to manage the property (lived in or not), and also to find renters when it is vacant. There is also a risk of property damage from different people living in your property. The decision to rent can also affect tax and financing considerations (see below).
Tax and Insurance Costs: Price of the home is certainly important, but you also need to factor in real estate taxes, homeowner’s insurance, and flood insurance into your total cost of ownership for your vacation home. These costs can vary widely depending on the location. The IRS allows you to rent out your vacation home up to 14 days without any income tax ramifications. After that the IRS considers the rental income taxable and also allows you to deduct operating costs of the property such as utilities, property management fees, and home insurance premiums. When buying your vacation home, you may want to also consider how long you plan to keep the property, as potential capital gains or depreciation recapture could result from selling a secondary investment property in the future. This is not an exhaustive list of tax issues and you should discuss your specific financial situation with your Modera Wealth Management team as well as your CPA.
Financing: Vacation home prices are on the rise lately, but mortgage rates are still near all-time lows, and mortgages are widely available for borrowers with good credit. That said, most lenders view second-home purchases as riskier loans (think about it — if you have another place to live, you may not care as much about defaulting on the second home mortgage). As a result, lenders typically will require larger down payments and charge higher interest rates on second home mortgages compared with those for primary residences. You will also need to prove that your cash flow is sufficient to carry a second mortgage.
Modera Can Help Weigh the Pros and Cons of Buying a Vacation Home
It sure sounds fantastic right now to splurge on getting away from it all once pandemic restrictions finally lift around the world. We would love to talk to you more about your dreams and goals of a potential vacation home purchase. Modera stands ready to help you think through the considerations and trade-offs.
1 National Association of Realtors: https://www.nar.realtor/blogs/economists-outlook/vacation-home-sales-are-getting-a-pandemic-boost
2National Association of Realtors: https://magazine.realtor/daily-news/2020/11/09/buying-frenzy-heats-up-in-second-home-market
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