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Home Finances: Home Away from Home

Buying a beach house sounds nice, right? Be sure to do the math before taking the plunge.

This article appeared in the Summer 2021 issue of This Old House Magazine. Click here to learn how to subscribe.

Summer 2021 Home Finances, beach house illustration Carl Wiens

Owning a second home for extended vacations, weekend escapes, or family reunions has never felt more appealing. Even before the pandemic, the market for second homes was heating up thanks to historically low mortgage rates and a prolonged stock market rally. Then 2020 ushered in an era of remote work, making vacation homes that could double as full-time retreats that much more attractive.

The yearning for a second home isn’t likely to fade away soon, even as offices and schools reopen. “People are more comfortable buying homes hours from their job now,” says Redfin lead economist Taylor Marr. “They still think they can take four-day weekends; the hybrid remote-work model is driving demand.”

But before you join this rush to the waterfront­—or the mountains or the desert—you need to understand the potential costs.

Assess Your Resources

Lenders consider second homes a riskier bet—you’re not there all the time to oversee the property. Plus, adds Greg McBride, chief financial analyst at Bankrate, “it’s not the roof over your head, so there’s a higher likelihood of a default if things turn bad.” As result, you’ll probably have to put down 20 to 30 percent. Your interest rate could be as much as one percentage point higher, too.

To get as low a rate as you’d pay for a mortgage on your primary home, you’ll need that high down payment, a high credit score (740 or more), and sufficient income to cover all your housing payments­—no more than 28 percent of your income. Even if you’re buying a home to rent out for part of the year, lenders won’t give you credit for that cash when approving a loan.

Calculate All the Costs

Beyond mortgage payments, you’ll need to factor in all the other expenses that come with home ownership: insurance, property taxes, maintenance, and repairs. Don’t assume your primary home is an accurate reference point.

Homeowners insurance could prove more costly than you expect. For one, insurers take into account that the home will be unoccupied part of the time. You can compensate for not being there by installing a central alarm system, a front-door camera, water-leak and heat sensors, and other surveillance tech, says Janet Ruiz, director of strategic communications at the Insurance Information Institute. “You can use technology to your advantage to keep insurance costs down.”

The bigger problem may be your view of the ocean or forest. “People tend to buy second homes in beautiful places that are disaster prone,” Ruiz says. And insurers may charge more in regions that often see natural disasters like hurricanes and wildfires. Buying near a body of water may mean you’ll have to buy flood insurance to cover damage from rising water.

Property taxes are another ongoing expense, and because 2017 tax reform capped the deduction for state and local taxes at $10,000, chances are that some or all of it will not be tax deductible­. The interest on a second mortgage­ (of up to $750,000) still qualifies—up to the limit. ­Another tax twist: When you sell the home you’ll owe taxes on the entire gain, unless you make it your primary residence first.

Finally, don’t ignore maintenance and repair costs. Common rules of thumb for how much to budget every year include 1 to 3 percent of your home’s value and $1 for every square foot of livable space.

Consider it a Moneymaker

The economics of buying a second home can change if you plan to rent it out when you’re not there. “With the rise of Airbnb and other vacation rental sites, it’s lower risk to buy a second home, knowing people will want to rent it,” says Marr. One caveat is that many vacation towns, concerned that area homes are becoming unaffordable to locals, are putting limits on short-term rentals. Check what laws are on the books, and what’s pending.

If you rent your home for just 14 days a year or less—a nice option in places that host major events—you don’t owe a penny of tax on that income. Beyond 14 days, the tax picture becomes more complicated. You must declare rental income, but you can also deduct many costs, including advertising, property management fees, mortgage payments, repairs and maintenance, and utilities.

When you use the house part of the year and rent it at other times, the math is trickier. “You have to split up costs and deduct them in proportion to the amount of time you spend there,” says tax expert Lisa Greene-Lewis. You may be able to deduct up to $25,000 in real estate losses against your ordinary income each year, if you “actively participate” in the work of maintaining or renting it.

Keep in mind that your insurance costs are likely to go up if you rent for more than 14 days total per year. In that case you may need to add a floater or rider. Some insurers may require a landlord policy. Whatever you do, don’t hide what you’re doing from your insurance company. You might find that damage isn’t covered if you kept quiet about tenants. As Ruiz says, “With online listings, it’s pretty easy for an insurer to track down how much you’re renting it out.”

Expert advice

“Renting out a second home can be advantageous because you’re earning income and can take more deductions than on your principal home.” —Lisa Greene-Lewis, CPA and tax expert, TurboTax

Summer 2021 Home Finances, man and house on percent symbol Carl Wiens

What’s your financial plan?

When you see how much vacation home prices are rising, you may think buying one is a good investment. But home values in vacation towns are more volatile than other markets—and more sensitive to the economy and stock prices. “You usually see back-off in vacation areas when the market is down,” says Redfin’s Taylor Marr.

Certified financial planner Louis Barajas doesn’t consider a second home part of an investment portfolio, unless it’s strictly a rental property. “It’s an illusion that you’ll sell it for more,” he says. Plus, an investment should bring in cash, not cost you money. “If you look at the money that goes out every year, it’s not an investment,” says Barajas. “It’s a luxury.”

Review your entire financial plan to make sure buying a second home won’t throw you off track, he advises. “But if you’re following your plan to get to financial independence and retirement, go ahead and buy your dream home.”