Looking to purchase of an investment property or second home? Read this first.
Owning a vacation home has been a part of the American dream for decades. The idea is tempting. You can buy a property near your favorite vacation spot, real estate is a tangible place to put your money, and perhaps you might rent it out and make a return on your investment. These reasons are what attract buyers looking for a “safe” investment asset. In fact, according to the National Association of Realtors’ 2018 Investment and Vacation Home Buyers Survey, which tracks home sales made in 2017, more than 7 in 10 vacation and investment property owners believe now is a good time to buy.
Real estate is riskier than most people realize. Aside from the opportunity cost of tying up money in your property, there are some serious threats you need to consider.
According to the Census Bureau, two-thirds of today’s homeowners have a mortgage on their current homes. Buying a second property may substantially increase your financial risk. To keep your risks to a minimum, make sure your total debt payments (mortgages, car payments and credit cards) are less than 36% of your total income.* Be aware, many mortgage companies are happy to lend you amounts that substantially exceed this total.
If you buy a second-home condo, you’ll have to pay a maintenance fee for lawn-mowing, garbage pickup and repairs. There may even be additional “special assessments” for major repairs such as a new roof.
Say you buy a home that is not a condo. Now, you must be disciplined to secure money aside for these services. A rule of thumb for budgeting is to set aside 1–2% of your home’s value every year. Major repairs could run you an additional 2-3%.
Should you decide to not reside at your vacation home for most of the year, and have renters occupy it, you will need to hire a professional property management company to maintain the home. While their fees may vary depending on location, for a single property, fees tend to be around 10% of total rent.**
You can expect to pay at least $70 a month on homeowners’ insurance. This brings up another important note, investment in a top-notch security system. Unoccupied homes are easy targets for vandalism and burglary. Systems today will allow you to keep watch on your property from hundreds of miles away, but monitoring fees can range from $30-70 per month.
Let’s not forget real estate taxes which can range between 1-2% of the property value. Still considering the option of renting out your second home? Be careful, this may trigger some unpleasant tax surprises. Renting out your second home for more than 14 days a year, will consider you a landlord, according to the Internal Revenue Service. At this point, you will have to declare your rental income at income-tax time, which consequently will cause you to pay higher taxes (though as a landlord, you’ll also be able to write-off certain expenses associated with owning a home).
Tips for Buying a Second Home
- Calculate all costs involved before you buy. In addition to a down payment and mortgage payments, you’ll also be responsible for taxes, insurance and maintenance costs. Try out our Rental Property Return Calculator to get a sense of the returns versus costs of a second home.
- Talk to your financial advisor about how buying a second home will factor into your larger financial plan. Be sure that you are not sacrificing your other financial goals with the purchase of a second home.