13 Jul What to Consider When Buying a Second Home
Do you dream of owning a ski, beach or lake house? Well, you’re not alone. In fact, according to leading statistics company Statista, roughly 2.1 million people last year said they plan to buy a second home within the next 12 months1.
If a special hideaway is on your wish list, then planning ahead is highly recommended in order to remain financially sound. To help you make an informed purchasing decision, we asked Gratus Capital Director of Financial Planning Kevin Woods, CFP® for some advice. [This is really strong, considering our disclosures. How about – To help you get started, we asked Gratus Capital Director of Financial Planning Kevin Woods, CFP® for his thoughts on making a detailed plan, first.]
What follows are six key considerations Woods encourages you to ponder before signing on the dotted line for a second home.
#1 – Estimate Real & Unexpected Costs
The very first consideration for buying a second home is to ask yourself if you can actually afford it, says Woods.
“There are many people that think they’ll buy their second home, rent it and make money, or make enough from rental income to substantially subsidize their bills,” says Woods. “Unfortunately, a great deal of the time this doesn’t turn out to be true. Generally, it’s because many home buyers underestimate the actual carrying costs of owning a second home, above and beyond a second mortgage, property taxes and insurance.”
These Additional Second Home Expenses May Include:
- General maintenance & repairs
- Security system
- Mowing & lawn services
- House cleaning services
- Internet & cable
- Water & sewer
- Trash & recycling removal
- Seasonal maintenance for heating, cooling, hot tub/spa, fireplace, gutters, septic pumping, pesticide spraying, etc.
- Opening and closing of pool, spa and irrigation system
- Long-term maintenance for exterior painting, driveway sealing, roof and appliance replacements
- Travel expenses to reach second home
- Insurance riders, e.g., snowmobiles, pool, speedboat, etc.
- Flood insurance
- Property manager
Remember to account for association fees, such as condo fees, says Woods. Additionally, watch out for an association’s periodic assessments.
Examples Could Include: A one-time $1,500 fee assigned to each condo owner for a new roof, a $5,000 fee for a town-mandated water system upgrade, or a $7,500 assessment post-hurricane damage, and so forth.
Woods also reminds us to look out for individual state property taxes, since some can be significantly higher than what you’re currently used to with your primary home.
Woods recommends that once you’ve isolated all of your variable expenses, double them for the first 10 years of ownership. If you can afford your second home after doubling all monthly variable expenses, then more than likely you can actually afford it. “Keep in mind that at any moment you could lose your job,” says Woods. “If this were to happen to you, do you have enough buffer to continue affording your second home?”
Bankrate® provides a simple home loan calculator that you can use to generate a quick snapshot in qualifying for your second home.
#2 – Identify Usage: Renting, Personal Use or Both
It’s important to decide if you’ll use your second home for personal leisure, as a rental or both. The key reason to make this determination before purchasing a second home is due to tax ramifications.
According to Investopedia, as long as you use the property as a second home and not a rental, you can deduct mortgage interest and property taxes the same way you would for your primary home. You can rent your property for 14 days or less each year without needing to report this as income to the IRS.
However, the financial education portal adds that when you rent out your second home for 15 days or more and either use it for less than 14 days or 10 percent of the number of days the home was rented, it’s now considered a rental property, and you must report all rental income to the IRS. Of course, you’ll be able to deduct a portion or all of your rental expenses, including mortgage interest, property taxes, insurance premiums, fees paid to property managers, etc.
TurboTax provides some detailed scenarios of renting versus personal use and the respective tax ramifications here.
Also, keep in mind that the market fluctuates. A property that is easily rented today may take weeks or maybe even months to rent a few years from now. “We simply don’t know what the real estate market will demand from year to year,” says Woods.
#3 – Titling Your Second Home
If you’re renting your second home, Woods suggests forming a Limited Liability Company (LLC) for the property, helping to protect your personal assets if your rental business is sued. For investors owning a property outside of their resident state, Woods suggests that you title your second home within a revocable trust, helping your loved ones avoid probate should anything happen to you.
#4 – Manage Borrowing Requests & Minimize Resentment
According to Woods, often when you purchase a second home, you’ll start hearing from long-lost relatives and friends asking to stay over or even borrow your second home outright.
Therefore, it’s important to plan ahead and set limits. The first question to ask yourself is, will I allow others to use my property? If so, who and for how long and how often? If you do allow others to use your second home, it’s important to establish rules, such as no smoking or pets, or no one under the age of 21 without an older adult.
“The most important thing to keep in mind is that your vacation home is yours,” says Woods. “You’ve worked hard and have been financially responsible, enabling you to purchase a second home in the first place. And while it’s nice to have guests or to do a favor for someone who needs an affordable vacation alternative, you do not owe anyone a place to stay. Nor do you need to provide an excuse as to why they’re not allowed to use your second home. You’ll enjoy your hideaway more when you manage your expectations, not others’.”
Real Simple provides some great examples of guilt-free strategies for saying no to various types of requests from friends and family members. All of us at Gratus Capital especially enjoyed the first strategy, “Saying no for the sake of your wallet.”
#5 – Estimate Time & Pressures
The concept of buying a second home is exciting, says Woods. Yet many buyers forget to take a step back and realistically consider exactly how much time they actually have to use their second home.
“I’ve seen second homes work out well for families that have very young children,” says Woods. “However, when kids enter middle school their activities become more of a commitment, to the point that they may be penalized if they miss a game or practice. Your 9-year-old may love skiing or camping now, but as he ages, he may lose interest and resist the idea of driving to the mountains. Ask yourself if you’re prepared to manage such situations.”
Also, it’s important to ask yourself if you’ll feel pressured to use your second home every time you vacation versus taking a different vacation, given that you’re paying a substantial amount of money to maintain your second home. Woods says that vacation home owners often feel a pressure to vacation at their second home. This travel limitation can ultimately lead to resentment.
#6 – Maintain Formal Co-Ownership Agreements with Friends & Family
If you’re considering co-owning a second home with a close friend or family member, Woods suggests that you have a clear agreement before signing on the dotted line. “Keep in mind that people’s lives change, and not everyone is successful at projecting their future goals,” says Woods.
“For example, someone may decide they want out of the house because they need the money to help pay for their child’s college education.
It’s important to discuss the nitty-gritty when creating your co-ownership agreement. In fact, if any member of the two parties starts to get agitated with developing an agreement, this could be a sign that you may not want to get into business with this individual. If you’re unable to have ongoing, open and difficult conversations with your co-owners, then the partnership will likely fail.”
At a minimum, Woods suggests that you include the following in your agreement:
- A list of shared expenses and distribution of expenses.
- Facilitation of repairs.
- Usage scheduling, who can use the house and when, including key vacation periods?
- Guests, who, how many and how frequently?
- House restrictions, e.g., no smoking, no pets, no adult children without parent present, etc.
- Buy-sell agreement. The latter would allow you to take out life insurance on the co-owner, enabling you to buy his or her share of the property in the event of their death. Otherwise, you could end up sharing your second home with your best friend’s adult children who may not like your established rules.
“I’m all for individuals and families purchasing a second home,” says Woods. “I, too, value quality time and relaxation with my family. Still, it’s imperative that you consider both the financial and emotional factors associated with owning a second home. If you can afford it, that’s terrific. However, do you have the patience to manage it, including enforcing boundaries regarding friends wanting to use your special hideaway? Owning a second home, even if you have the money, isn’t for everyone.”
At Gratus Capital, we take our clients’ lifetime goals very seriously. This includes their desire to secure a second home, whether it be for a personal escape or as another form of income. However, the purchase of a second home has both short and long-term ramifications on your financial well-being. It’s important to weigh the purchase of a second home within your overall financial plan, particularly tax and estate implications.
If you have questions regarding the purchasing of a second home or any other question pertaining to your overall financial health, including taxes and estate planning, as well as investment and wealth management, please contact us. In delivering financial advisory services, we aim to be your collaborative partner and dedicated advocate.
The above article is intended to provide generalized financial information; it does not give personalized tax, investment, legal, or other professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you or your business.