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Monday, January 8, 2024

Should You Buy a Second Home?

Seniors in the market for a vacation property have a lot to consider before making the leap, from location and cost to financing and use. Here’s the lowdown.

For many older adults, part of the American dream is owning a second home. A recent Ameriprise Financial survey of financial advisors found an estimated two out of three high net worth clients (those with more than $1 million in investable wealth) own a second home, and a third of their clients who don’t are interested in having one in the future.

Part of the reason the number is so high, of course, are the many years prior to March 2022 when interest rates, and thus mortgages, were at historic lows. Most buyers could afford to use the property as a vacation home.

Why Have a Second Home?

“The data uncovered that the vast majority (81%) of affluent clients primarily use second homes as a vacation destination or a place to get away from the stresses of everyday life,” said Marcy Keckler, senior vice president of financial advice strategy at Ameriprise Financial. “Other common reasons were better weather (49%), rental income (41%), and having a venue for gatherings (25%) with family and friends.”

A third of those surveyed had an ulterior motive for the purchase; they will move into their second home when they retire. 

“There can be an advantage to purchasing a second home before you’re done working so that you can pay off the mortgage before you officially retire,” Keckler said. “This strategy can make it easier to weather future economic downturns by eliminating or reducing a significant monthly expense.” 

Seniors Financing a Vacation Home

If you can pay cash for that home on the lake, more power to you. You’ll have a more competitive offer. You may be able to borrow against investments. “Ask your advisor to help you weigh the pros and cons of different financing options, as well as how the additional outlay might affect your progress toward other important financial goals,” says Kathryn Thompson, a Merrill Financial Advisor in Albuquerque, New Mexico.

But if you will be financing, prepare to meet more stringent underwriting requirements and contribute a heftier downpayment than with your primary home. Additionally, mortgages for second homes usually run 0.5% to 0.75% higher, although in some cases they may actually be less than listed rates if the home is not rented out.

You’ll want to check your credit score, since a number below 640 will likely put you out of the running for traditional financing. However, if you have a lot of equity in your first home, you may be able to use it to buy your second.
  • A cash-out refinance is when you get a new mortgage on your home. Most lenders will finance up to 85% of the value of your home. But you’ll have closing costs and the interest is figured at today’s rates.
  • A home equity loan or HELOC uses your home as collateral to generate a second mortgage. Home equity loans are generally distributed as fixed-rate, lump sum loans. HELOCs, which have variable rates, are more often paid out for expenses over time. Both of these options may enable you to draw 85 to 90% of your home’s equity.

Be aware that to meet most lender requirements to be classified as a vacation home you’ll have to keep it for your personal use and enjoyment at least six months of the year. It must be a single unit, and if you do short-term rentals, it can’t be managed by a property management company. It also must be at least 50 miles away from your primary residence. Check with individual lenders to verify their rules.

Is Owning Another Home Right for You?

Consider all the implications of owning a second home before you buy. Would it be cheaper to rent a place and not have to worry if the air conditioner needs to be replaced or a tornado comes through? If you envision years of family gatherings, talk to your children first. They may prefer a ski vacation over a place on the water in Florida, for example. Will they want to come visit often?

Don’t forget that another home comes with its own headaches no matter where it is located. Things break and wear out. Expenses for HOAs, property taxes and the like go up. You may decide you need to update, and who’s going to take care of the lawn?

Make sure to visit the area several times before you commit. Go in the off season to experience the worst weather. Eat at the local restaurants, shop and stay for a while to see if you’re bored or enthralled. Would you have more fun choosing different areas to visit, making rental a lot more fun than being tied to one spot?

Renting Out a Second Home

One way to defray some of the costs of another house is to rent it out part of the year. First make sure the community and/or town doesn’t have restrictions against renters. Talk to a local real estate agent about what similar places are renting for.

You may be able to deduct operating expenses, depreciation and repairs, mortgage interest, and property taxes, depending on how you are renting the home out. Talk to your tax professional about deductions and the guidelines around them.

More people in the home will mean more headaches and more wear and tear on the place, including furnishings. You’ll need a reliable cleaner and someone to manage for you, unless you want to take on that considerable job. Management may cost about 10 to 12% of what you bring in. Additionally, you may find that the season when you want most to be at your vacation home is the same one when most of your rental profits can be made. 

Whatever you decide, be sure and consult financial, tax and real estate professionals before making up your mind. While real estate tends to appreciate over time, there are eras and situations when that has not occurred. Do your homework before you commit, and you may just find your dream (second) home.