Despite a pandemic and recession, demand for second homes in the U.S. doubled in 2020, a recent Redfin study found.
This interest in second homes — primarily vacation homes — outpaced the 50% increase in demand for primary homes, the study found.
A second home comes with unique financial considerations. Before you go on the hunt for a vacation home or investment property, ask yourself these five questions:
1. What’s My Goal?
It’s important to decide whether your second home will be used for vacation or rented to generate passive income — or a combination of the two. That will affect your search process and how much you’re willing to spend.
“If it’s a vacation home for the family, then you may be willing to pay more for that since it’s a lifestyle decision,” says Miranda Biedenharn, a real estate agent with RE/MAX Alliance Realty in Dayton, Ohio “If it’s an investment property like a rental or a flip, you’re more likely trying to get the house for pennies on the dollar.”
For example, you may want to use a second home as a rental property for a number of years, but eventually retire there. If you know where you plan to settle down, you can get everything set up in advance and cover the home’s mortgage by renting it out.
If you’re buying a second home as an investment, you should research or speak with financial advisers to understand how it compares to more traditional forms of investing, like an individual retirement account (IRA) or mutual funds.
U.S. stocks have outperformed real estate over the past 10 years; the S&P 500 index of stocks on Wall St. grew 13.6% per year from 2010 to 2020, analysts at Goldman Sachs calculated. By comparison, the S&P Case-Shiller national index of home prices grew 4.60% per year over the same period — but pure returns aren’t the whole story, and your needs and preferences may vary.
2. Where Do I Want to Buy?
Be realistic when picking the location of your second home. You might be thinking about a beach house or ski condo, but you should consider how easy it would be to reach from where you live currently.
If you choose a second home that’s difficult to get to, requiring for example a connecting flight or a long drive, you could find it’s more of a hassle than an enjoyment. However, if you’re buying only to invest, the distance may not matter as much.
“It depends on what that second home is for you. If it’s going to be a more recreational home, then you’re more likely looking for the perfect home. If you’re just using it for work or as an investment property, then you’re not going to be as picky about some things,” says Biedenharn.
With a hot housing market across the U.S., prices are currently high in many places considered highly desirable for vacation properties. According to Redfin data, the median sale price in so-called “seasonal towns” grew 21% year over year in October, to $420,000.
Some of those places can be good places to retire to, as well.
Local real estate agents are seeing increased interest from out-of-town buyers, says Faylen Silva, a real estate agent in Hidden Valley Lake, California. She says she’s seen more interest than usual from these types of buyers in her area over the last few months. The demand is mostly coming from people wanting a summer vacation home or planning to retire soon, she says.
“A lot of times I see people come this way because (it’s) a lake community, which is a big draw for summertime getaways, and it’s very affordable,” says Silva. Hidden Valley Lake is roughly two hours away from San Francisco and Sacramento, “and many see themselves retiring here down the line,” Silva says. “People see it as a smart financial decision because it serves two purposes.”
3. Can I Afford Two Mortgages?
Even if you’re in a good spot financially, don’t underestimate the cost of owning a second home.
This is especially true if a second home means a second mortgage. You may have money for a down payment now, but think about the future. After all, “you have to remember that you don’t live in the purchase price — you live in your monthly payments,” Ryan Serhant, a New York real estate veteran and star of “Million Dollar Listing New York,” told us in October.
Lending standards might also be more stringent for a second home. You’ll likely need to put down more if you’re seeking financing, Silva says.
“You’re going to need to be a stronger buyer to get a second home,” she says. “You’re going to be paying a larger down payment and you won’t qualify for those first-time homebuyer type loans.”
Having an emergency fund is important for everyone, but owners of second properties would be wise to have enough savings to cover two home mortgages for at least six months.
If you’re going to rent the property, you’ll want to be prepared to pay for it on your own in case a tenant moves out and you can’t find someone to immediately replace them.
4. Can I Keep Up With the Costs of a Second Home?
Then you will have to consider how this will affect your budget over time.
“You’ll need to be able to afford all the things that go along with owning a second home,” says Silva.
Remember, you’ll have to deal with essentially two of everything: two mortgages, two property tax and insurance payments, twice the maintenance expenses, and more. That’s why you need a solid financial plan in place, with a good understanding of what money is coming in and what money is going out.
That includes utilities, property taxes, insurance, repairs, and possibly other costs. The amount of money you’ll need to set aside to cover the extra costs associated with a second home depends on the purchase price of the home, the home’s condition, the type of home, and whether you’re renting it, using it full-time, or doing a combination of the two.
For example, some types of homes may have additional required monthly costs. If you purchase a condo, co-op, or a home in an organized community with shared services, you usually have to pay condo fees or homeowners association (HOA) dues.
When you’re not living at your second home but someone else is, you don’t always have the ability to tackle problems immediately. That means you may want to add the cost of a property management company to your budget.
Another cost to consider is property insurance. Insurance rates on vacation or rental properties typically run higher than insurance for a primary home.
One common rule is to set aside 1%-3% of the home’s sale price for annual maintenance and repairs, says Biedenharn.
5. What’s My Exit Plan?
Your long-term plan may involve owning that second home forever, or it may not. Regardless, it would be prudent to have an exit strategy, just in case you want to get rid of it at some point.
Give yourself enough time to get out. Many areas are experiencing a seller’s market, so now can be a great time to list a home for sale, but market conditions fluctuate and it’s not guaranteed you will enjoy similar conditions when you want to sell.
Also, consider the obstacles life throws at you, and make sure you’re prepared for worst-case scenarios. The market in that area might fall, your employment status could change, you could face an emergency, or you might simply find yourself stretched too thin financially.
“You’re more likely to default on your second home than your first,” says Silva. “So you want to make sure you’re in a good financial position before jumping into that second home purchase.”