How to Buy a Second Home
Buying a second home is an exciting pursuit and one that comes with many advantages beyond serving as a fun getaway for you and your family. From renting the home out and bringing in extra cash each month to planning for your retirement, buying a second home can be a great investment. But, it’s important to know exactly what you’re getting into prior to crossing the threshold. Here are key things to consider when searching for your home away from home.
Know What You Want
The “why.” Take a good look at your reasoning for buying a second home. Do you vacation a lot in a certain area and think it will be cheaper to have your own place? Are you looking to use it as a future investment? Both of these are valid justifications, but thoroughly evaluate the costs. In the end, you’ll want to be happier and in good financial shape, too.
Hire a local real estate agent. It can be tricky looking for a home outside your area. An agent can help you get to know the markets in the specific areas you’re looking to purchase. You’ll feel better knowing you have a trustworthy resource to turn to when making the big decisions.
Is it a vacation home? You want it to house your family and guests comfortably. And make sure the travel time fits your lifestyle.
Will you retire there? Maybe you’re buying a second home that fits your family now, but you’re not sure it’s where you’ll retire someday. If that’s a possibility, consider that you may want to sell the property at some point in favor of another location.
What time of year will you spend there? Buying a summer or winter home is altogether different than buying a home for all four seasons. It’s important to keep in mind the cost of heating and cooling the property, and don’t forget to consider the proper steps to take when closing up the property for the winter or summer. You don’t want to come back to find your pipes have burst from freezing, or damage from a leaky roof.
Planning on renting? You’ll want to consider location, size and amenities that appeal to renters. This is a great way to help pay the mortgage on your second home, but keep in mind, if you’re going to rent your property there are some additional things to know. Familiarize yourself with landlord/tenant laws and the Fair Housing Act, and remember to budget for unexpected expenses. If you plan to rent your second home and generate income, be sure to let the lender know. Not all homeowners policies provide coverage for rental or income properties, and you may need special coverage for the home and any of its contents.
When will you sell? If this is an investment you’ll sell, find out how properties have performed in that area over time.
Know What You Can Afford
Understand your finances. If you’re considering a second home, you’re most likely in decent financial shape. But, look beyond what you’ll be paying monthly for the mortgage and calculate what it will cost for taxes, homeowners insurance, as well as utilities and maintenance. Being mostly debt free, saving for retirement and having enough for a down payment are important things to consider as well. Taking a broad view of your finances will give you a better idea of what you can afford when you actually start to house hunt.
Do you have a buffer? If you’ll have mortgages on both your primary and secondary homes, mortgage underwriters will tell you how many months of reserves you’ll need for both. The length of the reserve will vary from bank to bank, but you can get a good idea of the reserve depending on the property type.
Plan for a larger down payment. Some lenders require a higher down payment for your second home — up to 30 percent.
Be prepared for higher interest rates. Increased risk often means increased interest. It’s not uncommon for loans on second homes to carry higher interest rates.
How much debt do you have? Lenders will pay a little more attention to your debt-to-income ratio when reviewing your loan application for a second home. Typically, you’ll have a difficult time getting approved for a mortgage if your debt-to-income ratio exceeds 43 percent. A ratio of about 40 percent can be a safe bet, meaning about 40 percent of your monthly gross income goes towards paying the minimum amounts due on debts like your credit cards bills, student loans, car loans, etc., and the remainder can help go towards your mortgage.
Insurance. An additional home means more insurance, there’s no doubt about that. Your American Family agent is ready to work with you to help find the best policy for your second home. A rental property may require a different type of policy designed specifically for rental/income properties. Keep in mind, if you’re renting your second home more than 14 days of the year, it’s considered a rental property.
Additional expenses. Property taxes, utilities, maintenance fees and insurance start to add up. A good rule of thumb is to set aside 1-2 percent of the home’s purchase price for annual maintenance.
Get advice. Consult a tax professional about the ramifications of owning a rental property. Below are a few considerations:
- If you use a home for your own enjoyment rather than as rental property, mortgage interest is deductible just like on your first home — up to a maximum for combined debt.
- You can deduct property taxes on your second home, whether you rent it out or not.
- Your home is considered a rental property for tax purposes if you rent it more than 14 days a year. Essentially, you will:
- Report rental income
- Deduct expenses at the percentage you rented it versus used it personally. Note: Fix-up days don’t count as personal use.
- Deduct property manager expenses
- Make depreciation deductions based on the percentage you use it for rental
Talk with a CPA or tax advisor for accurate information about interest rates, loans, tax write-offs, etc. They’ll be able to guide you through the nitty gritty details that go along with renting a property and owning a second home in general.
Split ownership. Perhaps a relative or friend is considering a vacation home. You can potentially save a lot of money by operating under a Tenancy in Common, where both parties would split complete ownership of the property. Your agent may be able to assist you with any policy implications of this ownership form.
Consider the logistics. Will school or work commitments affect your ability to use your vacation home? How far is it from your primary home? Is it close enough for weekend visits or are week-long trips more reasonable? Will you need a property manager to watch the house? All good questions to consider when buying your second home.
Like all lifelong dreams, buying a second home requires a lot of thought, hard work and planning. But you can do it! Once you've made the big move, talk to your American Family agent and check out our homeowner coverages to make sure your new hard-earned dream never goes unprotected.