What to consider before buying a second home

Key Points

  • The decision to buy a second home involves a balance of financial and personal calculations.
  • Before buying, consider location, how you plan to use the home and how much time you're willing to put into maintenance.
  • Depending on your financial situation, a second home could be a smart investment – especially if you decide to rent it out.

Dreaming of a condo on the beach, a cabin overlooking a pristine lake or a villa on a golf course? You’re not alone. When it comes to buying a vacation home, sales have taken off in the past few years. According to a 2016 National Association of Realtors® (NAR) Investment and Vacation Home Buyers Survey, Americans bought approximately 920,000 of them in 2015—  the second largest number of sales since NAR began tracking them in 2003.

A second home can be a wonderful escape as well as a sound investment. Mortgage interest on a second home may be deductible for up to $1.1 million of total home debt (combined acquisition and some home equity indebtedness for both your primary and secondary residences together). You may also be able to deduct property taxes (but not maintenance expenses, unless the property is a rental business). Ultimately, the decision to buy a second home involves a balance of financial and personal calculations. Here are a few to consider.

Ask yourself the right questions

If you’re contemplating a second home, you probably have an idea of the area where you’d like to live. You’ve no doubt scouted the locale, on- and off-season. You’ve also probably envisioned your life in your second home. And that’s the point where you should ask yourself some important questions.

  • Will you have lots of visitors and need room to accommodate them?
  • If you’ll be there for months at a time, how will you handle health care, banking and other essentials?
  • Will this be your retirement home, or an investment to own for a few years and then sell?
  • If you have a significant other, how does each of you plan to use the home?

Factor in home maintenance costs

Another key consideration: Maintenance. More specifically, how much will the home need? Freestanding homes, of course, require more maintenance than condos, and new properties tend to need less work than old ones. Most experts recommend you budget 1 to 2 percent of the home’s cost each year for maintenance. Even if you hire out your maintenance needs, remember there’s often some level of inconvenience (and noise) involved in home projects.

Do the math

Purchase price is only one consideration. You also need to factor in costs relating to furnishing and outfitting the home, as well as such ongoing expenses as taxes, insurance and possibly a property manager to check on the home when you’re not there. Finally, consider costs related to spending time in the area. For example, will you drive there or will you need transportation when you arrive?

Research before renting out your property

It can be a smart financial move, but renting out your vacation home will take extra time. According to the 2014 Vacation Rental Marketplace Report from homeaway.com, owners who actively rent their properties do so 36 weeks out of the year and spend an average of nine hours a week managing the process. As a result they’ve been able to generate an average of $28,000 annually of rental income. A time-saving option to consider is engaging a local property manager or realtor. Just keep in mind that they typically ask for 10 to 40 percent of the total rental income as payment for services.

Renting your vacation home may also result in income tax consequences depending on whether the property is deemed for personal or business use. If you rent it 14 days or fewer per year, the income generally does not need to be reported to the IRS, no matter how high the rent is. After 14 days, the property will generate taxable rental income. You’ll need to report the income, and you may also be able to deduct the expenses — including management fees, mortgage interest, repairs, taxes, utilities, legal fees and marketing expenses — based on how much the property is used for personal versus rental use.

Remember, investing in a second home is a decision that must be carefully thought through. Talk to your financial advisor about how buying a vacation home might work into your overall plan.