Should you buy a second home?

Key takeaways

• Before you decide to buy a second home, think about how much it will cost you and whether you'd be OK with staying in one place for vacations for a long time.

• Before you buy a second home to rent out, you should know the rules.

• Buying a second home can help you spread your investments, make extra money, and have a place for family get-togethers.

During the worst pandemic, the market for second homes went through the roof. Things are very different now, though. Another study from Redfin shows that many people are changing their minds about buying a second home. The number of people looking for mortgages for second homes is at its lowest level in seven years. This is mainly because housing costs are high, and people have to go to work every day.

The lower demand may be good news for those who want to buy another home. There is more power to negotiate when there is less competition. Wait to get a second home. Read on to see if you're ready for the long-term duties that come with it.

Important considerations before buying a second home

Full financial Impact

Having a second home means you are twice responsible for all the money matters. For instance, if your primary house has a problem with a sewer pipe and your second home's HVAC system needs repair soon after, you'll get two huge bills right after each other.

Besides accidents, though, you'll have to pay twice as much for everyday things: 

• Second mortgage payment, which includes property taxes and homeowner's insurance 

• Utilities

• Upkeep

• HOA fees

• Travel costs to get to the home

• Rental management fees 

Keep your big-picture goals in mind', says Daniel R. Hill, president and CEO of the Richmond, Virginia-based investment advisory firm D.R. Hill Wealth Strategies, LLC. You can afford these costs right now. 

Before buying a new home, Hill tells his clients to think about these money issues: 

• Are you saving at least 15% of your current income for retirement?

• Are monthly cash funds available for six months (preferably nine months)?

• Are you out of credit card debt?

• Is your current home paid off?

• If applicable, have you established a college fund for your children?

Hill says you might feel safer buying a vacation home if you check all these boxes. 

Financing options 

Judith Corprew, executive vice president and top compliance and risk officer at Patriot Bank in Stamford, Connecticut, says that before giving you a loan, banks will check to see if your income is enough to cover your costs. Get ready for your income, job history, assets, and debts to be looked at, along with your credit report.

It's similar to applying for a mortgage. Depending on your loan type, it may be faster. Some options are: 

• Mortgage for a second home 

• Home equity loan on the house you already own 

• Home equity line of credit (HELOC) on the house you already own 

• Get cash out when you refinance your present mortgage. 

Credit card or other high-interest debt can look better on your credit report to lenders if you use a HELOC or other low-interest products to combine your debts into one smaller payment. John Sweeney, founder and managing partner at Momentum Capital Partners in Boston, says this. 

Ability to travel to other destinations 

If you've lived in Clearwater Beach for ten summers, the warm Gulf waters might not appeal to you as much as the trouble and cost of storm season. In the same way, a 10-hour drive through beautiful scenery to a house in the mountains can quickly become a chore after a while. 

The question is: Do you want to spend much time on vacation in one place? It might make sense if your family loves the place so much. But consider whether you'd instead plan several trips to different areas or stay in the same place every summer (or every other weekend). 

Renting out your second home 

Collecting rent money is one smart way to pay for your vacation home. You should know the rules, though, before you buy. Remember that laws change from state to state, city to city, and neighborhood to neighborhood. What is OK in one area might not be OK in another. 

On the other hand, Airbnb is against the law in New York City unless the apartment is rented out for more than 30 days or by a regular resident. 

People who want to buy a condo should check to see if the rules allow renters or rentals like Airbnb. The same is true for HOA rules. In some countries, homeowners' associations are trying to limit short-term renters. 

In addition to rent, owners should plan for cleaning services, insurance, and general upkeep costs. Since you can't be sure that the rent will come in, you can pay for all these costs, like the monthly mortgage, on your own. 

You might also have to give up the time you want to spend in the house to attract buyers, which could make having a second home less appealing and pointless. What would you do if you wanted to be there during spring break but could get a rental fee covering many of your property taxes? 

As it turns out, the time you want to be there is probably when there are the most renters, says Timothy Parker, managing partner at Regency Wealth Management in New Jersey. "When we look at the numbers with our clients, we often tell them they should rent a house for a week or a month instead of becoming landlords." It's often less expensive and easier to do. 

Taxes on vacation homes

The IRS classifies a vacation home as a rental or personal residence. It is a personal domicile if it is rented for no more than 14 days per year; if it is rented for more than 14 days, it is classified as rental property. Generally, rental income must be reported, irrespective of its classification.

Importantly, you will not be eligible for the mortgage interest tax deduction if your vacation home is categorized as a rental property. Nevertheless, if your rental expenses surpass your rental revenue, you may be eligible to deduct losses on your rental. These losses should be detailed on Schedule E of Form 1040. 

Consult with a seasoned tax expert regarding your prospective liabilities and deductions. Remember that you may only deduct interest paid on $750,000 or less in mortgage payments across your residences. 

Long-term potential for investment

As anyone who recalls the 2007-2009 housing crisis can attest, home values cannot be guaranteed. Following the apex of the housing market in 2006, national home values plummeted 33%, eroding equity and forcing borrowers into foreclosure. 

Numerous specialists concur that residential real estate is not the optimal asset class for wealth accumulation despite its potential for appreciation. Those seeking to accumulate funds for retirement or other long-term objectives may find a secondary residence to be an unsuitable investment basket. Conduct thorough research on the local housing market to ascertain whether it has established itself as an attractive destination for vacationers and other purchasers of secondary homes. 

Reasons for owning a second home 

Despite the time and money invested, there are numerous excellent reasons to purchase a second property, such as the following: 

• A second residence lets you diversify your investments beyond conventional stocks, bonds, and 401(k) plans. Additionally, a second residence can function as a buy-and-hold investment and be a valuable legacy to future generations, given that real estate generally appreciates in value. 

• Possibility of working there full time: You can eventually convert a secondary residence into your primary residence, thereby preventing the need to relocate during retirement. 

• Produce passive revenue: You can generate passive income by listing your property on rental platforms such as Airbnb, VRBO, or any similar website, provided that the area has lenient regulations concerning short-term rentals. 

• Provide a venue for all family gatherings and reunions: A second residence can serve as the focal point for family and friends to convene and detach themselves from the pressures of everyday existence. 

Would you benefit from purchasing a second home? 

Consider the advantages and disadvantages of deciding whether or not to purchase a second property. The benefit of owning a second property is having a vacation destination to which you can return year after year without making reservations. Additionally, a secondary residence may serve as a valuable financial asset, potentially augmenting one's wealth in the long run in the event of a substantial appreciation in its value.

However, you must also consider your financial situation. Are the costs associated with second-home ownership, including ongoing maintenance, upkeep, and property taxes, within your financial means? Expenses of this nature may impose a financial burden on one's budget or restrict the capacity to travel abroad.

Additionally, if you are contemplating purchasing a second property to rent, ensure that the area you prefer does not fall within a jurisdiction where Airbnb-style rentals are prohibited by local law. Additionally, consider the time and effort required to be a landlord and whether or not that is a profession you genuinely wish to pursue.

How to buy a second home 

Before purchasing a second residence for which financing is required, ensure you can accommodate a second mortgage payment within your budget. Additionally, you must account for homeowners insurance, utilities, and property taxes in your budget. Before searching for a second residence, you must locate a real estate agent and obtain mortgage pre-approval.