Buying a vacation home, or second home, implies the reassuring yet untold truth that you already have a principal place of residence. That underlying truth means that you are good with numbers and everything about real estate, or that you have reached a level of financial sophistication by talking to the right people and cultivating a network of real estate specialists over the years. For all that good news, you still need to do your homework and pay attention to a few things when planning the purchase of your vacation home. These include organizing the search process effectively, figuring out the funding plan, and understanding the pros and cons of owning a vacation abode.
How to Organize the Vacation Home Search Process?
One of my real estate professors in grad school used to say that many investors fail to generate a stream of effective, easy-to-implement home search ideas because they use common techniques like network search and agent search. These are good, time-tested tactics, but try something else when looking for a vacation dwelling. Search online, go to specialized real estate websites like Prime Location and input your criteria to see what is available out there. You can also place ads online, indicating specifically the type of property you are looking for, the budget limit, the neighborhood and other nebulous criteria like overall safety and the look-and-feel of the surroundings.
How to Finance a Vacation Home?
Talk to your banker or financial adviser before financing a second residence. Ask the adviser the options that may be available to you, especially when it comes to outright purchase, home equity loan, HELOC or another type of hybrid financing arrangement that only the bank can explain. The goal here is to get the best deal possible and reduce your overall interest charges. Think about the box and go wild, banking-wise. You can apply for a loan at an online bank, the sort of virtual institution that is reputable yet has fewer operating expenses than its real-life counterparts and, therefore, charges less interest. With a home equity loan, you must make a series of fixed payments each month until the loan's maturity, and the interest rate usually is also fixed. With a home equity line of credit (HELOC), you have a variable interest rate, and your monthly remittances also fluctuate.
What Are the Advantages of Owning a Vacation Home?
Owning a vacation home has many benefits:
- For starters, the property generates regular income flowing into your coffers, making you laugh all the way to the bank. Besides rental income, the house's value will appreciate over time unless the whims of the economy dictate otherwise.
- Second benefit: when filing your income tax return, you can deduct mortgage interest and property taxes from your gross income.
- The third advantage lies in the more amorphous notions of familiarity and convenience, which make you feel at home when you return to your vacation habitat or when the property is unoccupied during the low season.
- Fourth, a holiday house – same thing as vacation home - puts you in a good position in the race to successful retirement. With your property, you can borrow to finance other ventures that could help you generate even more cash. Another benefit to include in the retirement equation pertains to the fact that you could live in your vacation home for the rest of your post-retirement life.
- The fifth benefit lies in the fact that you can use the place for gatherings, be they for family reunions or friendly get-togethers or even as rental space for professional events.
What Are the Disadvantages of Vacation Home Ownership?
There are many cons to owning a vacation residence, including:
- You must fork over a substantial sum to buy the property outright or to make a down payment on the property.
- Home maintenance is another issue to consider, especially if you live far from your vacation abode and need someone to take care of the place and maintain some type of hygienic order around the house.
- Travel time is a critical element to factor into your decision to buy a vacation home. If your principal place of residence is hundreds, if not thousands, of miles away, you should think about travel costs versus the rental cash you are generating from the property, and see whether it makes economic sense to continue maintaining the property.
How Can I Get a Mortgage for a Vacation Home?
Applying for a mortgage may be your best option when purchasing a vacation, especially if you don't have enough cash to cover the purchase or if you cannot gather the required amount from private parties, such as friends and relatives. The requirements for second home ownership are less stringent that what lenders typically mandate if you want to purchase an investment property.
However, talk first to your bank to determine options that are available to you. Remember, you can also tap into the equity in your first home to contribute to the down payment you ultimately will make. So you may not need to fork over that much cash than initially anticipated.
When you contact your bank, be prepared to answer questions about your income, current debts and credit history. These are part of a typical mortgage application for a second home. Other things you should have an answer for include questions about the property itself, whether you have enough cash for a down payment and closing costs, and whether the appraisal process is complete and in sync with the lender's underwriting requirements.
What Are the Tax Implications for Vacation Home Ownership?
Tax implications for vacation home ownership vary, depending on how you want to use the property. Seek the counsel of your accountant or, more generally, someone familiar with real estate tax laws. Broadly speaking, the Internal Revenue Service allows you to deduct interest expense on your second home as long as you don't use it as a rental property. In this case, you deduct the full amount of interest payments and property taxes, up to a specific limit that currently is $1 million.
If you use the property for investment purposes, say, renting it for more than 14 days during the year, you must report the income to the IRS. The agency then would allow you to claim expenses as well, including things like depreciation, repairs, operating and maintenance expenses, and uncollected rents – unless you are a cash-basis taxpayer, in which case you wouldn't be able to claim uncollected rents because those rents weren't part of your income.
When purchasing a vacation home, consider the pros and cons of this type of transaction and your overall status of homeownership. Property ownership provides benefits like rental income and tax deductions, and drawbacks that run the gamut from high upfront cost and travel to home maintenance. Other things to consider when buying your vacation residence are ways to fund the purchase as well as how and where to conduct the property search.