Are You Considering Buying A Vacation Home?

Summer season is winding down and this is the time that many people begin reminiscing about their great family trips.  While doing so, some people may have thoughts of purchasing a second home in a vacation destination.  While emotions certainly play into this decision, there are many financial issues to consider before signing on the dotted line.

Location, Time, and Cost

A significant factor in the decision to purchase a second home is how much you would realistically use it.  While you may enjoy your vacation time at the same destination each year, you need to honestly evaluate if you will be able to use this property enough to make it worthwhile.  Location is one of the most important considerations.  It needs to be a convenient location, or it will be difficult to make the trip on busy summer weekends.  Another consideration is how often family schedules will conflict with using the property during the busy summer months.  Many families with young children like the idea of having a vacation home because they value the idea of spending quality time together, but once children become involved in sports and other activities, their schedules do not allow for many opportunities to use the home.  For example, many high school sports begin practicing in the beginning of August and hold practices during spring break.  At the beginning of the summer, there are often family graduation parties and weddings during the weekends that could prevent you from traveling to your second home. 

Before beginning the search, it is important to evaluate whether or not you can realistically afford a second home.  Even if you have two mortgages, lenders will expect you to stay within the debt-to-income limits dictated by Fannie Mae and Freddie Mac.  Your total debt payments, including all mortgages, cannot exceed 36% of your gross income.  However, if you plan to rent your vacation home, you can count some of that assumed rent as income when calculating the ratio.  It is important to remember that a vacation home is not a liquid asset and can be more difficult to sell a vacation property than it is to sell a primary residence. 

There are also many costs that are associated with vacation homes that are not readily apparent.  The homeowner’s association fees vary widely between properties in the same market, and you should compare the amenities to the fees being charged.  If you are not interested in golf or a pool, you may not want to buy in a development that has these amenities, as the association fees would usually be much higher.  Also, there are utilities, property taxes and maintenance charges to consider.  If you purchase a single family home, you need to be willing to spend your time taking care of the yard and doing maintenance on the home, or you need to be able to pay someone to do it for you.  It is also a good idea to review the financial statements of the homeowner’s association to make sure there are adequate reserves to cover unusual and non-recurring expenses that may occur. 

Rental Income and Taxes

Many people decide to rent their vacation property when they are not using it to offset the expense of owning a second home.  If you decide to rent, don’t forget that you either need to pay a property management company or be willing to pay for advertising and managing your rental property.  There are also tax issues to consider if you decide to rent.  You can rent your property for up to 14 days a year and pocket the rental income without having to declare it on your tax return.  Planning to use your vacation home for more than 14 days of rental income requires an in-depth analysis on the personal and rental time to determine the tax implications.

Vacation-home owners that consider retiring to their second home (or a third home) after selling their first home may qualify for the capital gain exclusion of $500,000 (married filing jointly), or $250,000 (for single filers) on the second home in addition to the first.  To do so, you must have made the second home your permanent residence for at least two of the five years before selling.  This extra exclusion may be useful for those with homes in Illinois and Wisconsin, but who eventually want retire to Florida.    

Final Thoughts

There are many factors to consider when buying a vacation home, but many times it becomes an emotional, rather than a financial decision.  I own a second home near Lake Geneva, Wisconsin, and although it has not appreciated significantly since purchasing the home, it has been a wonderful experience for our family.  We have created many happy memories that cannot be measured in financial terms.  Understanding all of the costs involved and the tax implications are critical in making the right decision, but sometimes the choice comes down to how you would like to spend your free time with your family and friends.