Kristin McKenna, Senior Contributor
June 20, 2023
Owning a second home or vacation property can sound enticing. But it can also be very expensive, both in terms of time and money. There are also hidden costs associated with owning a second home. For some individuals and families, buying a vacation home makes a lot of sense. It's comfortably affordable and the home is heavily used annually, even if just seasonally. But in other situations, the hassle and cost of maintaining a property from a distance plus the desire to travel to new destinations makes buying a second home an expensive mistake.
Cost of owning a second home
There are many real (and sometimes hidden) costs associated with owning a second home. To start, you'll need to essentially hit 'copy-paste' on everything you see around you at home now. Perhaps it won't need to be the same quality or quantity, but just outfitting a second home with the basics can be expensive. Here are some of the general costs you'll incur after buying a second home:
- Appliances, furniture, furnishings like rugs, linens, cookware, and décor
- Cable, internet, utilities
- Funds for a down payment, cash purchase, or monthly mortgage payment
- Property taxes, insurance, local taxes or fees, possibly association dues
- Periodic landscaping/mowing, maintenance, cleaning, care-taking
- Repairs, improvements
- Transportation (getting there, renting/shipping/buying a new car)
While the list above doesn't contain anything surprising, sometimes the cost of a particular line item is.
For example, in certain locations such as sought-after vacation destinations, property taxes can be quite high. It's all relative though. If you're coming from the New York/New Jersey area, property taxes will likely be less than what you're use to.
Changes to tax law in recent years increased the carrying costs of a second home for many taxpayers. State, local, and property tax deductions for those who itemize are limited to $10,000/year. In addition, the overall limit on deducting mortgage interest has been reduced to $750,000 for new loans since 2018.
Some would-be second home buyers might also be surprised at the cost of getting a mortgage on a vacation house. Depending on how you plan to use the property, lenders may increase the down payment requirements, interest rate, or simply not offer a loan program that meets your needs.
For example, if you plan to rent the second home for more than two weeks per year, the lender may consider it an investment property, requiring a minimum 20% down payment and only permitting conforming (non-jumbo) mortgage loans. Lenders do differ in this regard, but you'll need to do some homework. Further, because second homes are considered more risky than primary residences, the interest rate will typically be noticeably higher.
As climate change continues to spark weather-related disasters like wildfires and hurricanes, getting homeowners insurance is becoming more expensive. And in other cases, impossible, as insurers are pulling out of some markets in places like California and Florida altogether.
Rising seas will also increase the costs for homeowners' insurance in beach and coastal communities. Flood insurance might not make you whole, especially if you're relying on rental income to offset the costs of owning the second home. Finally, also consider how climate change and natural disasters could impair your ability to sell the house in the future if your preferences changed or for financial reasons.
Reducing the cost of owning a second home by renting it
Not all vacation homeowners are keen on the idea of defraying costs of the property by renting it, and some towns or associations may have limitations on short-term vacation rentals. However, renting the property can help reduce the cost of owning a second home—with some caveats. Generally, homeowners can rent a house for up to 14 days per year tax-free federally. But once exceeded, the entire amount of pro-rated net rental income is taxable.
In many situations, this means the homeowner would need to rent the vacation home significantly longer than two weeks to materially benefit from the added rental income. For example, assume a second home can be rented for $10,000/week and the carrying costs per week when rented (mortgage, insurance, cleaning, etc.) is $2,000.
If you only rent the home for 14 days, your net income is $20,000. Since you rented it only two weeks, you do not need to pay federal income tax on your rental income and any carrying costs associated with the property or renting it are not considered deductible. State tax implications are excluded from this simple, hypothetical illustration.
Now assume you rent your second home for a month. Your net rental income is $32,000 ($40,000 - $8000). However, now it's fully taxable. If you're in the 30% average federal tax bracket, in this simple example, you only net $2,400 more in exchange for renting your second home two additional weeks. (Although, if you consider the $4,000 of carrying costs that aren't deductible in the first scenario, the hypothetical profit gap widens to $6,400).
In either case, factor in the loss of use, wear and tear, and general hassle, and it may not be worth it for some investors.
Owning a second home means traveling less to other destinations
One of the hidden costs of owning a second home is less time (or money) to travel elsewhere. Everyone has different preferences, so for some individuals and families, this won't be an issue. But in other situations, the newness wears off after a couple of years, perhaps from the added effort of keeping up with two homes or the reality just didn't match the vision. Being aware of shifting preferences and needs is especially important if you're envisioning the second home as a future retirement home .
Depending on your willingness to rent the home and the vacation market in the area, you could still have options. Perhaps you opt to rent the home for the season and travel elsewhere. Following on the example above, if those figures were supported for 12 weeks, the after-tax income could be over $67,000. Not too bad! Obviously, these are fictitious numbers, so before buying a second home, consider what the figures might look like so you have a realistic contingency plan.
Time is valuable...so is money
Time is our most valuable commodity. Before buying a second home, consider how you will check in on the property. Cameras are great, but if the pipes freeze or a tree falls on the roof, who's going to deal with it? Reliable, trustworthy help is amazing to have but very hard to find. Especially for busy professionals, managing urgent household needs or tenant issues might be more than you bargained for.
Also consider what buying a second home means for your financial plans. You can only spend a dollar once. Will the property materially impact your cash flow and ability to save for the future or other near-term goals? If so, are you comfortable with the trade-off? We shouldn't put our lives on hold until retirement and there's no prize for being the richest person in the graveyard. However, real estate is often an emotional purchase. Factor in the cost and illiquidity, and it's easy to see how important it is to run the numbers and seek advice from your financial advisor for an independent perspective on the feasibility of the purchase.
Should you buy a second home?
Maybe! Again, it really boils down to your financial situation, preferences, and how you think that could change over time. For example, young families might find the only way to regularly vacation is to have their own place to go already outfitted with all the kids' stuff. But as the children get older and have weekend sports, activities, and friends back home, getting away isn't so easy.
The luxury home rental market is expansive, so if it doesn't make sense financially or otherwise to buy, you can still enjoy your success at a destination of your choosing. Sometimes, the flexibility to experience new places and opt to stay for weeks or months is the best approach. Then everything else is just someone else's problem.
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