HERE’S WHAT YOU NEED TO KNOW BEFORE BUYING A SECOND HOME

Buying a second home is an exciting prospect, whether you’re dreaming of a balmy beachfront property to get away from it all or dipping your toes in real estate investing. However, a second home purchase is also a significant financial decision that can carry serious risks. Owners must account for all manner of costs – from mortgage payments, property tax and homeowners insurance to utilities and ongoing maintenance.

Navigating these costs and complexities can be a daunting task, requiring an in-depth understanding of the housing market, home loans and long-term responsibilities like property management. Fortunately, we can guide you through the process and considerations of buying a second home to help you make an informed decision.

WHY DO YOU NEED A SECOND HOME?

The first step in purchasing another property is to ask yourself why you want or need it. We’re not trying to discourage you – second homes open a world of opportunities, but the specific opportunity you’re after will inform your financial strategy.

For instance, here are a few common reasons people buy another house:

1. You’re looking for an upgrade: If your primary home was just a starter, you might be looking for an upgrade – whether that means more space or a better location. This second home could also allow you to turn your first house into a rental property for additional income.
2. You could use a vacation home: Do you want to create your own slice of paradise? A second house can act as a getaway for you and your family, as well as a vacation rental property while you’re back at your primary residence.
3. The secondary property is in a prime location: If you’re tired of flying or long commutes, it might be wise to buy a second house closer to wherever it is you’re going. Depending on the location, this property can also be a key asset should you decide to lease or sell down the line.
4. You’re considering an investment property: For those with an eye on the future, a second property can also be a strategic investment. From regular rent income to capital appreciation, an investment property could create a potentially steady cash flow on the side.
5. The second home is for a loved one: Your second home purchase might not even be for you. Being able to house a friend or family member is a tangible expression of love and care that demonstrates your investment in their well-being.

WHY BUY A SECOND HOME?

If you already know why you’re buying a second home, the natural follow-up question is often, “Is now the right time?” While the answer is highly dependent on each home buyer's circumstances, there are a few reasons why now might represent a good opportunity to pull the trigger on that investment property:

FALLING MORTGAGE RATES?

Let’s start with the more timely and speculative line of reasoning: mortgage rates are expected to decline when the Fed cuts the benchmark interest rate.¹ While it may seem smart to wait on a second mortgage until rates drop, other buyers will be of the same mind, which could result in a more competitive real estate market and higher home prices. Buying now could mean avoiding competition in the future.

RELATIVELY LOW INTEREST RATES

As of April 3, 2024, the current average interest rates are relatively low for a home equity loan and a home equity line of credit (HELOC) – 8.59% and 9.04%, respectively, based on a $30,000 loan or credit line.² These rates are significantly lower than for the average personal loan³ or credit card⁴, which often enter the double digits.

HIGH HOME EQUITY LEVELS

Homeowners also have access to high levels of home equity, with the average amount hovering around $200,000 in 2023.⁵ With this equity, you may be able to easily fund the 20% down payment required by the typical mortgage lender. Leveraging home equity in this way can also help you preserve your savings.

9 POINTS TO CONSIDER BEFORE YOU BUY A SECOND HOME

While you might be convinced that now is the perfect time to purchase a second home, there’s still much to consider.

Here are eight points to ponder before buying:

1. KEEP THE BIG PICTURE IN SIGHT

Will buying a second home negatively impact your long-term goals, including saving for your retirement and paying for your children’s college? Will it affect the cash reserves that you should always maintain? If the answers to big-picture questions like these are no, you’re likely in a good position to consider a second home. But even then, you’re wise to consult a financial advisor before moving ahead.

2. AVOID ACTING ON IMPULSE

Think about why you want a second home. Is it to build a family legacy someplace where your kids and grandkids can gather year after year? Do you want a place to keep your parents close by or to give your college student a campus-adjacent pad? Do you want to split locations by season – a summer residence up north and a winter one in the south? Will it someday be your retirement home? If you buy on a whim, you could end up with a second home that doesn’t adequately meet your needs.

3. LOCATION, LOCATION, LOCATION

Buying a second home in a town by the ocean or in the mountains might seem like a great idea, but if you live very far from your chosen location, getting there might be so much of a hassle that you won’t go there often. If you plan to share the space with family members, it might be wise to buy a home that’s convenient for short weekend trips. If it will one day be your retirement home, it should have good access to needed resources and services.

4. WILL YOU NEED A SECOND HOME MORTGAGE?

You can pay all cash or get a mortgage that allows you to hold on to your cash and take advantage of today’s low-interest rates – or use a combination of these methods. Always shop around for a mortgage. Rates for second homes are typically a bit higher than rates for a primary residence.

5. HIRE A TRUSTED REAL ESTATE AGENT

Buying a second home outside your area or out of state can be tricky, as residential real estate is extremely localized. Hire a local agent, who will be in the best position to advise you on the market there.

6. EXPERIENCE LIVING THERE

Even if you’ve been visiting the same vacation spot for years, you need to view it from outside the perspective of a tourist. Rent for a while in the off-season to see how you like it and talk to locals about the pros and cons of living there.

7. USE YOUR FIRST HOME TO PURCHASE YOUR SECOND

Leveraging the equity of your first home can be a strategic way to purchase a second without having to dip into your savings or retirement funds. This usually involves using a home equity loan or HELOC to access the accumulated value of your primary residence, which provides the funds needed for a down payment on, or even the entire purchase of, a second property. Using home equity is a financially savvy move that can help you capitalize on your existing property to expand your real estate portfolio. However, we don’t generally recommend borrowing to purchase a rental property.

8. RENTING OUT YOUR SECOND HOME

Collecting rental income creates a cash flow and can be a smart way to subsidize your vacation property, but don’t buy investment real estate with borrowed money. If you want to own a rental, pay cash. Also, learn the laws governing rentals. They vary by state, city and even by neighborhood. If it’s a condo, find out whether the condo bylaws allow for rentals.

Consider using an on-site leasing company to help you find qualified renters and to help you manage the property when you’re not there. You will need a contingency plan and additional cash reserves for the rental property if rental income dries up. You also need to plan for additional costs and repairs when renting a property, so make sure to go over the numbers with a financial planner before making this decision.

9. CONSIDER TAXES

If you use your property as a true second home – rather than renting it out – you could get a tax deduction for mortgage interest and property taxes. However, if the home was acquired after December 15, 2017, this deduction is capped at $750,000 of total mortgage debt on both homes.⁶

Property taxes on the second home are also deductible, but the IRS limits the total deduction for all state and local taxes to $10,000 per return.⁶ Different tax rules apply to second homes that are deemed investment or rental properties. The rules are complicated, so it’s best to talk to an experienced tax professional to learn how they would apply to you.
 

TALK WITH A TRUSTED FINANCIAL ADVISOR

Whether you’re looking for a way to diversify your assets or just enjoy your favorite vacation spot more frequently, there are always pros and cons to buying a second home. In addition to these tips and considerations, have a conversation with a financial advisor and tax advisor to discuss your options and whether this is the right step toward your financial future.

¹ U.S. News. (2024, April 5). Mortgage Rate Forecast: Will Rates Go Down in 2024? Retrieved April 10, 2024, from https://money.usnews.com/loans/mortgages/mortgage-rate-forecast

² Bankrate. (2024, April 10). Current home equity interest rates. Retrieved April 10, 2024, from https://www.bankrate.com/home-equity/current-interest-rates/?zipCode=53593

³ Bankrate (2024, August 28). What is the average personal loan interest rate? Retrieved August 29, 2024, from https://www.bankrate.com/loans/personal-loans/average-personal-loan-rates/#:~:text=According%20to%20a%20Bankrate%20study,and%20even%20where%20you%20live.

⁴ Bankrate (2024, August 28). Current credit card interest rates. Retrieved August 29, 2024, from https://www.bankrate.com/credit-cards/advice/current-interest-rates/

⁵ Intercontinental Exchange (2023, August) 2023 Mortgage Monitor Report. Retrieved August 29, 2024, from https://www.icemortgagetechnology.com/resources/data-reports/august-2023-mortgage-monitor  

⁶ IRS. (2023, October 18). Frequently Asked Questions – Real Estate. Retrieved May 30, 2024, from https://www.irs.gov/faqs/itemized-deductions-standard-deduction/real-estate-taxes-mortgage-interest-points-other-property-expenses/real-estate-taxes-mortgage-interest-points-other-property-expenses-5