How to buy a vacation home
For those who can, buying a second home is suddenly more attractive, because remote work has become the norm in the pandemic. Why not work from where you like to vacation, where you really want to live?
“Stay-at-home orders and social distancing have given new value to the extra space,” says Danielle Hale, chief economist of realtor.com. “We are also seeing this in the luxury market, which could mean renewed interest from high-end buyers in finding a second home within a short drive of their primary residence.
Whether you are planning to buy a vacation home now or in the future, here are the steps to take.
How to buy a vacation home
As with any home purchase, buying in a new neighborhood requires serious thought and preparation.
Step 1: Determine What You Can Afford
Before you can buy a second home, it’s important to understand the costs you might be facing.
If there is a mortgage, then there are expenses for principal, interest, taxes and insurance (PITI). However, the very nature of a second home can also lead to other costs. If you are 150 miles from the property, for example, who will look after it? Who will control the property in the event of a storm? Will someone stop regularly to check for theft or vandalism?
If you are planning to buy a property by the beach or in a wooded area, check availability and cost of insurance before buying. You can’t get or keep a mortgage without the required insurance coverage, so make sure it’s both available and affordable.
Costs of owning a vacation home
In addition to your monthly mortgage payment, there are other expenses associated with owning vacation property, whether you finance them yourself or offset the costs with rental income. These expenses generally include:
- Maintenance and repairs
- Management and availability (if you rent)
- Furniture and household items
Tax implications of buying a vacation home
The 2017 tax reform radically changed property taxes. In theory, mortgage interest and property taxes generally remain deductible for primary and second homes, but in practice many people apply the standard deduction instead of itemizing mortgage interest and property taxes. Without these deductions, the economics of property have changed.
To offset the costs, vacation property owners may consider short-term overnight rentals through platforms such as Airbnb, FlipKey, or HomeToGo, as well as seasonal rentals through a local real estate broker.
According to IRS: “If you rent accommodation to others that you also use as a residence, limitations may apply to the rental costs that you can deduct. You are considered to use a dwelling as a residence if you use it for personal purposes during the tax year for more than the greater of: 1. 14 days, or 2. 10% of the total number of days when you rent it out to others at a fair rental price.
Translation: There are circumstances where rental money is not taxed; in fact, it does not need to be reported. Speak to a tax professional for more details.
Step 2: Find a local lender
It is best to seek out a mortgage lender specializing in second homes in the area where the property is located. The lender will have funding sources ready and understand the rules and specifics required of where you are buying.
How you finance, for example, depends on the location of your vacation property. For lenders, a second home carries more risk than a primary residence – in a downturn, borrowers are more likely to continue making payments on their primary residence. To offset this risk, buying a second home usually requires more upfront money and the financial ability to afford two homes, and comes with higher interest rates.
Things get even more complicated if the property is to be leased. Once the rent is taken into account, lenders wonder if they are financing a second home or Investment property. The difference is important because it is easier to qualify for the financing of a second home.
Another complicating factor arises when the property has unrelated people buying together – the lender wants to be sure that the property will not be devalued by quarrels between owners. The best approach is to have a written agreement, created by a lawyer, that shows how the property is to be owned and operated.
The list of complications is long, but the important point is this: An experienced lender with localized knowledge will be your best resource when looking to buy a vacation home.
Step 3: Decide how to finance your vacation home
Once you’ve found a lender, think about your financing options. You may be considering paying the advance payment thanks to savings, a refinancing of collection your main residence or a Home equity line of credit (HELOC). Saving is the best option because you won’t get into more debt.
While lenders can be liberal in some ways when financing a primary residence, vacation homes are different. FHA and VA funding are out – they’re only for primary residences – but conventional funding is available. Freddie Mac defines a second home as:
- It must be occupied by the borrower for part of the year.
- It must be a single-family dwelling.
- The borrower must have sole control of the property.
- The second home cannot be a timeshare.
- It should be suitable for year round occupancy.
- The property cannot be the subject of any agreement giving a management company control of the occupation of the property.
- Rental income cannot be used to qualify the borrower.
Loan conditions for a vacation home
- Debt-to-income ratio – For a main residence, borrowers can sometimes finance with a 50% debt to income ratio, or DTI. For a vacation property, think closer to 43 percent, or maybe a little more.
- Credit score – With a FHA loan, you can buy a primary residence if your credit score is 500 and you have a 10% down payment. For a vacation property, for which FHA loans are not available, you will need a credit score of at least 640.
- Advance payment – As a general rule, you can buy a primary residence with as little as 3% down payment. With a vacation home, you will need at least 10 percent.
- Reserves – In some cases, you can buy a primary residence with little or no reservations. For a vacation home, you will likely need reserves equal to two to six monthly mortgage payments.
Be sure to check mortgage loan requirements for vacation homes with different lenders – the financial stress created by the pandemic has caused many lenders to tighten their approval requirements.
Step 5: Compare Vacation Home Mortgage Rates
Mortgage rates for vacation homes are generally higher than financing a primary residence – about 0.5 to 1% higher. Make sure to search around for the best rates and conditions.
Step 6: Work with a local real estate agent
Buying real estate in a new area – or even one you’ve been on vacation in for many years – requires expert advice, so be sure to work with an experienced local real estate professional. . They will not only know which properties are available, but also why you might prefer one over the other, as well as local regulations or restrictions.
At the end of the line
If you are planning to buy a vacation home, think about how you will use it, how often, and whether or not you will rent it. One of the best ways to start is to live in a short term rental in the area. See if you really like the location. Consider schools, stores, and medical care if needed. What are the pluses and minuses? Speak with local real estate brokers and visit open houses. The more you know, the better your chances of getting the vacation home of your dreams.
Image courtesy of Getty Images.