Bill Fish and his family live in Cincinnati, but when he and his wife looked for ways for their children to spend more time with the grandparents, a vacation home in their resort community of Anna Maria Island, Florida, seemed perfect.
“It’s a simple three-bedroom ranch,” he said, with a “five-minute walk to the beach, and we also have a nice private pool.” His family vacations in the home twice a year and, when they’re not on site, they recoup about half their costs by renting the property.
Fish is far from alone. Last year, 21 percent of all homes bought in the U.S. were vacation homes — the highest percentage seen since the National Association of Realtors began recording the data in 2003. Investment properties remained a popular buy, too, comprising 19 percent of homes purchased in 2014.
Buying a second home can be exciting — and challenging. Before you bid on that mountain chalet or beachside bungalow, consider these tips.
1. Know How to Compare the Cost of Location
In niche markets where most vacation homes are, the cost of real estate will vary dramatically by location. “A $500,000 home on the lake may look a lot like a $300,000 home in the suburbs,” said Glenn S. Phillips, CEO of Lake Homes Realty, which specializes in lakeside properties primarily in the north Midwest and southeastern U.S. That’s because “the waterfront lot may be $200,000 more than a lot back home.”
To make more accurate comparisons between potential homes, Phillips suggests subtracting the location premium before comparing homes and prices.
2. Even Sellers Might Need More Cash Than Expected
Even if you’re just moving house and plan to sell the first home after closing on your new digs, you’ll probably need to be qualified for costs associated with both the old and new mortgage.
“Bridge loans are few and far between these days,” said Jeremy David Schachter, mortgage advisor at Pinnacle Capital Mortgage in Phoenix. “They were very popular before the housing crisis. These days, borrowers have to qualify for both mortgages if they are not selling one to buy another one at the same time.”
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3. Know How Much You Can Afford
“With a second home, you would have to qualify on all your monthly debts, including any outstanding loans and the new mortgage for the second home,” said Schachter.
For a vacation home that won’t be rented out, most buyers can finance up to 90 percent of the home’s value, according to Fannie Mae. However, buyers will still need to consider all their other outstanding monthly debts, including the payment for their primary residence and the cash left in the bank — known as reserves — after the transaction is complete.
4. Plan to Have Extra Cash in Reserve
If you plan to finance your second home, have cash stashed away. Most banks require second-home buyers to have at least two months’ worth of mortgage payments in the bank, after you’ve accounted for the costs for the new home settlement.
If you’re buying an investment property, you’ll need a minimum of six months’ worth of payments stashed away. If your credit score is below 680, expect that number to be even higher.
5. Your Credit Score Matters — a Lot
Just like when you bought your primary home, your credit score affects what rate you can get for your second-home mortgage. The higher your credit score, the more attractive the rate and the more you save over the life of your loan.
The lower your credit score, the more cash the bank will expect you have in reserve. If your credit score is below 680 and you’re planning to rent your new home, you might need to have up to 12 months of mortgage payments in the bank.
6. Be Prepared With a Large Down Payment
The vacation home market can be competitive. The more cash you have for a down payment, the stronger your offer. “In our markets (lake homes), about 70 percent of the deals are cash deals with no mortgage,” said Phillips. “For most vacation homes, many sellers don’t have to sell. If they can afford a second home, they often can afford to wait for a desired offer and not be in a hurry to take low offers.”
If you’re planning to finance a vacation home, a 10 percent down payment will usually suffice, so long as you meet the other mortgage criteria and you purchase private mortgage insurance. If you’re looking to rent your home, even just some of the time, it will be categorized as an investment property. Mortgage lenders can be more stringent for investment home loans, requiring at least a 20 percent to 25 percent down payment, said Schachter.
7. Don’t Rely on Online Valuation Tools
While online home price estimators can be a good tool when buying into a subdivision of similar homes, they don’t always work so well in vacation home markets. “The automated tools are still young, and the data is difficult in markets where homes are influenced by lakes, oceans and mountains,” said Phillips. “And these homes are often custom-built and vary greatly.”
In other words, an in-person appraisal is often the best way to figure out a home’s worth, particularly in resort areas, where home value is highly dependent upon location and individual home amenities.
8. Work With an Agent Who Fully Understands the Area
“Many second homes are purchased to focus on recreation or nature,” said Phillips. “This can create interesting ‘gotchas’ in a home purchase.” Areas with protected vegetation, rural road restrictions or unique land situations — like lake lots that are leased, for instance — can create big problems for an uneducated buyer.
Phillips suggested working with a real estate agent who is a genuine expert in the location and type of home you want to buy. “They will know the often hidden dangers lurking for out-of-area buyers,” he said.
9. Be Aware of Taxes
Different tax rules apply, depending on how you use the second home. If you rent for zero to 14 days per year, you’re not required to pay federal taxes on the rental income, according to TurboTax. If you rent the home for more than 14 days, you’re required to report all rental income, although you can deduct rental expenses for when the home is rented out.
“Each state can have very different property taxes, and these can vary for second homes, even if the homestead residence is in another state,” said Phillips.
There are plenty of reasons to buy — and enjoy — a second home. The Fishes plan to hang on to theirs for as long as the kids have grandparents in the area. “I’m not quite sure if we will retire there,” he said, “but we have no intention of selling it in the next 10 years. Our boys love it.”