The Baggage of a Second Home

Another summer has come and gone. While on vacation this year, you may have been noticed the many for-sale signs scattered among beach-front or other resort-like properties. And, with mortgage rates still at historic lows and the prices of many homes dropping, the thought may have entered your mind that now is the ideal time to purchase one of these properties as a second home. But before you start packing up the surf board or ski poles, make sure you consider all of the implications that owning another residence may have on your overall finances.

First, understand that financing a second home is more difficult than obtaining a mortgage for your primary residence. Typically, you need to meet higher credit score standards and your monthly debt-to-income ratio also needs to stronger. Banks prefer to see regular income when reviewing loan applications, so retirees — even those with a high net worth and strong credit history — may have difficulty obtaining loan approval.

For a mortgage to be guaranteed by Fannie Mae or Freddie Mac, many lenders require that a minimum down payment of 20% or sometimes as high as 30% to 35%, and the interest rate for second-home mortgages is usually slightly higher than the rate for your primary home.

In addition to loan considerations, you need to calculate the carrying cost of owning another home, including property taxes, utilities, maintenance, association fees, insurance and security. Keep in mind that insurance costs may be higher than anticipated if you are in a hurricane or flood zone, or if you rent the property on a regular basis. There also may be other costs that you do not anticipate initially, such as another car to keep at the second home or other recreational items such as bikes and boats.

Many investors assume that they will offset many of the ongoing expenses through tax deductions or rental income. Like with a primary residence, if you rent the property you generally would be able to deduct property taxes and mortgage interest (up to $1 million of total home acquisition debt), as well as other deductions. However, if you rent the property for more than 14 days yearly, you also must report all of the rental income on your tax return.

When you sell the home, remember that you also could be subject to capital gains taxes. Unlike with the sale of your primary residence, you do not receive a $500,000 exemption ($250,000 for single-filers) for capital gains on the sale of the property, and there is also no tax benefit if there is a loss.

If you plan on keeping the home in the family, you also need to consider a realistic scenario for passing the property to other family members. For example, re-titling the home to two adult siblings may cause difficulties when they have their own families or if they have different opinions on what to do with the property in terms of selling or renting it out in the future. While conflict may be avoided by including terms in a contract or using a trust before passing the home to the next generation, it’s important to be aware of any potential issues, and plan accordingly.

Owning a second home can be a dream come true, with memories of long walks on a beach, bike rides or white-powder skiing happily created year-after-year. Just make sure that you consider some of the other baggage that may come along before packing for your next vacation to your new home.