Winter is behind us, and spring is in full bloom. As you dream about your favorite beach, lake, or mountain trail, you might wonder, "What if we lived there?" The COVID-19 pandemic initially sparked a surge in interest for second homes among retirees. Ian Katz, a real estate agent in New York City, noted, "The pandemic brought people closer. They want exposure to multiple climates while staying connected with family.
Since 2020, the purchase of second homes has slowed due to rising mortgage interest rates. However, high mortgage rates are not necessarily a deal breaker for retirees and near-retirees. Katz explained that these groups are less likely to need large, long-term loans, often using their savings to buy new properties.
If you're considering a second home, think carefully before making this significant purchase. The wrong property can turn your dream into a nightmare.
1. Prices Are Near All-Time Highs
Even amid a real estate slump, homes in desirable vacation spots remain pricey. Katz warns that many towns now have full-time remote workers competing with retirees. Be conservative about budgeting and ensure you can manage ongoing costs for the new home, even if your income drops.
Mark Charnet, a financial adviser in Pompton, N.J., cautions that owning a second home could limit your ability to travel elsewhere. "You're tied to the same place. Unless you love the idea of having your own home and bed in each location, it might not be a good idea." Renting homes through Airbnb or Vrbo might be a better option for you.
2. Borrowing Is More Challenging
Mortgage rates are typically 0.5% to 0.75% higher for a second home compared to a primary home. Currently, mortgage rates are just shy of the highest they've been in 20 years. Expect to make a down payment of at least 10% on a conventional mortgage for a second home, though a larger down payment could help you qualify for a lower interest rate, says Katz.
3. A Test Drive Leads to a Smarter Purchase
Katz has seen retirees rush into second home purchases without fully understanding the area, leading to regrets. "Get a hotel or Airbnb for an extended stay first," he advises. "Sample the daily vibe."
Consider how the property will meet your long-term retirement needs. "Even if you run marathons today, that might not be the case 20 years from now," Katz notes. Think about how you'd manage with less mobility. How many steps are needed to get inside? Is the bedroom on the ground floor? Check if the local homeowners association allows mobility upgrades like a wheelchair ramp.
4. Upkeep and Maintenance Add Up
Charnet points out that people often underestimate the annual upkeep and maintenance costs of a second property. "They budget for the mortgage and taxes, but that's just scratching the surface," he says. Maintenance expenses can be high, especially for older homes. Charnet, who owns 25 rental properties, sets aside 7% of the home's value annually for maintenance and repairs. For a $300,000 property, that's $21,000 a year.
5. Property Taxes Can Be a Nasty Surprise
States like Florida, Nevada, and Texas don't have income taxes but can have high property taxes. Katz suggests checking how property taxes will be assessed after you buy. Some localities adjust taxes based on the new selling price, which can be significantly higher than what previous owners paid.
6. State Income Taxes Depend on the 183-Day Rule
Buying a second home in a low- or no-income tax state could reduce your overall tax bill, but it depends on how long you live there. Many states, including New York, follow the 183-day rule, meaning if you spend more than 183 days in New York, you'll be taxed as a resident.
7. Renting Is Possible but Not Always Easy
Renting out your unused property can generate extra income, but short-term rentals can be challenging. Tim Touchette, owner of Attache Corporate Housing in Washington D.C., says leases are typically a year or longer. If you're away for six months, finding a renter for that exact period can be difficult. Managing rentals means acting as a part-time landlord or hiring a property manager, which costs about 8% to 12% of the monthly rent. Check if the building has rules restricting rentals.
8. Tax Breaks Depend on Usage
You can deduct home mortgage interest and property taxes for a second home if you live in it at least 14 days a year or 10% of the days you rent it out, whichever is greater. Renting a second home for up to 14 days per year doesn't require you to pay income taxes on the rental income. For longer rentals, you'll owe income tax on the rental income but can qualify for more tax breaks, such as the cost of repairs, maintenance, insurance, and property management.
When you sell your second home for a profit, you'll owe taxes on the entire gain. There isn't an exclusion like for selling your primary residence. However, if you own the home for at least a year, you'll owe long-term capital gains, which are much lower than the income tax rate.
9. Insurance and an LLC Protect Your Investment
You'll need a homeowner's insurance policy for your second home. Charnet suggests getting quotes from local insurers, as they may offer better rates. If you plan to rent out your second home, consider setting up a limited liability corporation (LLC) to own the property. This protects your primary residence and savings in case of a lawsuit.
10. Inherited Properties Aren't Always Welcome
Vacation homes can become a point of contention among heirs. Charnet advises considering whether all your heirs are interested in the property. If not, you could adjust your estate to ensure those who aren't interested receive other assets, such as cash, investments, or life insurance payouts.
In summary, buying a second home requires careful consideration of financial, logistical, and practical factors. Make sure to evaluate all aspects before making this significant investment.
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