Sixty-five percent of the U.S. population are homeowners. Around four percent also have a second home. But the pandemic, coupled with low interest rates, caused an eighty-seven percent uptick in interest and demand for a second home.
Rising mortgage rates have somewhat cooled the market, but the demand for a second home is still significantly higher than it was pre-pandemic.
What are some things to keep in mind when considering the purchase of a second home?
Reasons to Buy a Second Home
Identifying the reason why you want to buy a second home is crucial. Your reason will determine the location, budget, and how you plan to use your new property. Some reasons to acquire a second home include:
● Airbnb or Vrbo. Renting out a second home or condo as a vacation rental through an online booking company, such as Airbnb or Vrbo, can provide passive income.
● Commuter crashpad. If you or your spouse regularly commute to a city for business, purchasing an apartment or condo there may make sense.
● Family member use. If parents, siblings, adult children, and friends are regular visitors, having a second home close by may be handy. Or you may want to purchase a condo in the same town as your college student if you visit frequently.
● Rental property. Single family homes can be rented out long term and can provide secondary income.
● Vacation home. This may be part of the American dream or bucket list living for those who like to have regular getaways in a town or state that they hope to retire to someday.
Pros and Cons
● An Airbnb or Vrbo can be more lucrative than having a traditional rental property. You determine when your property is available or not. Terrible renter? They are only there for a few nights and not a year.
● If you have a commuter crashpad, you don’t have to live in a hotel the nights you are away from your primary residence. It may be cheaper to have your own place than to stay in a hotel several nights a week.
● For a property that will be used for family, it can be nice not having people stay in your home. It gives everyone more breathing space when visitors are in a separate residence. When you don’t have visitors, you may be able to use it as an Airbnb to earn extra money.
● Rental properties can provide steady monthly income. Depending on the real estate market, your property may increase in value and add to your total assets.
● Owning your own vacation home can potentially save money on vacations because you are staying in your own place rather than a hotel. Plus, you can stay for a longer period of time. The home may increase in value over time, and you can potentially earn passive income if you rent it out when you aren’t there.
● Airbnb or Vrbo monthly income may vary depending on occupancy rate. Expenses will be higher because of utilities, furnishings, and required cleanings.
● Airbnb, commuter crashpad, family member use, and vacation homes all have the added expenses of mortgage, property taxes, monthly utilities, furnishings, maintenance, and insurance.
● For a rental property, you will need to be a landlord or hire a property management company to do it for you.
Count the Costs
Paying for two households can potentially be a huge risk. But, depending on whether or not you rent out the second home full-time or part-time, there can be money to be made and potential tax breaks to be had. Things to consider include:
Down payment. Depending on the type of loan you wind up with, you may have to come up with a larger down payment on a second home, which adds to upfront costs.
Mortgage interest deduction. Depending on the breakdown of personal versus rental use, you should be able to either claim the mortgage interest as either a tax deduction or as a business expense.
Second home expenses. What about the cost of maintaining and operating the property? If it is an investment property, you should be able to deduct those costs as business expenses.
Homeowners insurance. The insurance policies for a second home can cost more than those for your primary residence. Depending on the location of your second home you may need extra insurance to cover floods or earthquakes.
Additional life and disability insurance. Usually mortgage debt is a factor when purchasing life and disability insurance. Leaving your surviving spouse with enough funds to cover the mortgages (of both your primary residence and a second home) in the event of your death or loss of ability to work may mean increasing your coverage amount.
Is It a Smart Investment?
After all the thinking and planning that goes into finding a second home, you may still be wondering: is this a good investment? It depends on your current financial situation. Some questions to ask yourself include:
● Am I contributing 10 to 15 percent of my income into a retirement account?
● Have I paid off all outstanding credit card debt?
● Is my primary residence paid off or close to it?
● Do I have an emergency fund that I can live on for three to six months if I lose my job or my ability to work?
These money questions are important to answer “yes” to before considering the purchase of a second home. You want to ensure that an additional property doesn’t take away from your retirement plan or goal to pay off debt.
Crunch the numbers of your current financial situation and costs of a second home, and you will quickly see a clearer picture. After taking care of your financial must-dos, do you have enough left over cash flow to take care of the expected and unexpected expenses of a second home? You might or you might not.
Owning a second home, whether for personal enjoyment or rental potential, is an exciting thought. However, it is important to consider the real cost of a second property as well as your current financial situation.
Written by Matthew Delaney