So You Want to Buy a Vacation Home...
As the weather warms up, many people are thinking about summer plans—and possibly dreaming of buying a vacation home. Although it may sound appealing, purchasing a vacation property isn't something to be entered into lightly. If you're considering this major commitment, here are some important questions to ask yourself.
What's your budget?
In addition to the cost of the property itself, you need to consider other expenses such as:
- Property taxes
- Repairs and maintenance, landscaping, and utilities
If you'd need to take out a second mortgage to finance the purchase, you'll have to decide if getting further into debt makes sense. Do your due diligence to see if you're a candidate for a second mortgage, including reviewing your current credit score and your debt-to-income ratio (your total monthly debt payments divided by your gross monthly income). Lenders generally look for a debt-to-income ratio below 36 percent.
How will you use the property?
A key factor in the financial calculation is whether you'll use the home solely as your personal vacation residence, turn it into a rental property, or some combination of the two. Many people use rental income from a second home to offset the mortgage until the property is paid off.
Tax considerations. If you rent out the home for fewer than 15 nights per year, you can keep the income without reporting it to the IRS. If you rent it out more than that, you must report the rental income, but you also qualify to claim certain deductions.
How much you get to deduct depends on how you divide your personal time at the property and the rental time. If you spend 14 nights per year at the home, or more than 10 percent of the number of nights it is rented out (whichever is longer), the IRS considers the home a personal residence, and you can write off typical rental expenses against your rental income.
Who will manage the property?
If renting the vacation house is part of your plan, consider who will take responsibility for:
- Overseeing the property (including handling cleaning, repairs, and the like)
- Coordinating with renters
- Assessing the local rental market to price the property accordingly
If you live a considerable distance away from the second home, hiring a local property manager is an expense that can't be overlooked.
What kind of insurance will you need?
Insurance is a necessary protection for any piece of property, and vacation homes can present additional risks. There are many options to choose from, so it's important to do your research. Some insurers may offer a second-home endorsement to your primary residence coverage instead of selling you another stand-alone policy, which may be a more affordable choice.
Other insurance considerations include:
- Location: Be sure to look into the neighborhood crime rate, natural dangers common in the area (such as flood or hurricane risk), and the history and state of the property itself.
- Amount and type of liability coverage: Whether the house will be vacant for extended periods or rented by many tenants over the course of the year, it's imperative to ensure that you have sufficient coverage.
How easy would it be to sell?
If you decide to sell the property eventually, you'll want to be sure you can make a profit. Popular vacation areas tend to have higher property appreciation rates, but location isn't everything. You should plan to invest in upgrades and maintenance along the way to maximize the return on your investment.
Making a wise choice
Buying a vacation house can be an exciting accomplishment (and possibly a great investment), but it requires serious consideration, especially from a financial standpoint. Ensuring that you have the means to comfortably purchase a second home—and recognizing the additional expenses that come along with it—is key to making a smart decision that your family will enjoy for years to come.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
© 2015 Commonwealth Financial Network®