How To Buy a Second Home: Financing, Taxes, and More

Second homes may seem just like primary residences, but when it comes to financing, taxes and expenses, there are some important differences. Before you step into the second home market, you’ll want to understand just what you’re getting into so that you don’t make a poor financial decision. But if you plan ahead, do the math and understand all of the regulations and restrictions that apply to second homes, you could potentially end up making a lucrative decision. Here are the things to know about buying a second home.

Benefits of Owning a Second Home

There are three primary benefits of owning a second home:

• Income potential: A second home can be rented out for additional income. Just remember that to get a second-home mortgage, you must live in the property for at least a portion of the year. Otherwise, you’ll have to take out an investment property loan, according to The Mortgage Reports.

• Long-term investment: Real estate, particularly in desirable areas, tends to appreciate over time. A second home can be a path to building additional wealth.

• Lifestyle benefits: You can use a second property as a vacation home.

Assessing Your Financial Situation

In the current marketplace, homes are at near-record levels of unaffordability. This means that purchasing a second home can be a financial burden for many. To determine if you can really afford a second home, you’ll have to use a calculator and crunch some numbers. If your debt-to-income ratio, including the cost of the second home, is more than approximately 45%, you likely can’t afford an additional property.

Remember also that loan options for second homes are different than those for your primary residence. You’ll generally need a credit score of 680 or higher to qualify, and you’ll have to put at least 10% down on your mortgage.

Choosing the Best Location for Your Second Home

Location has long been touted as the most important thing when it comes to real estate, and second homes are no exception. If you’re planning on renting out your second home, do some market research to help you locate the best areas for vacationers. If you only intend to use your second home for personal use, pick an area that has the attributes you need, be they accessibility, convenience, solitude, and so forth.

Navigating Financing for a Second Home

You can get a traditional mortgage for a second home, but the terms and requirements will be different. You can’t put less than 10% down on a second home, for example, and you generally need a credit score of at least 680. With a down payment of at least 25%, you may be able to get a second home loan with a credit score of 640, according to The Mortgage Reports.

Generally speaking, you can’t get a second home loan if your debt-to-income ratio is more than 45%, and you’ll need cash reserves of at least two to six months of living expenses.

Tax Implications of Buying a Second Home

Tax planning for second homes can be complicated. If you’re purchasing a second home, you may want to consult with a tax advisor.

You can generally deduct mortgage interest on your second home just as you do on your primary residence. You can also deduct typically deduct the property taxes you pay on it. However, if you use your property as both a vacation home and a rental property, you’ll have to split up your deductions and expenses.

Specifically, if you rent out your property for 14 or fewer days in a year, you do not have to report that income and can deduct your mortgage interest and property taxes just as with your primary residence. But if you rent for more than 14 days, you’ll have to compute the ratio of personal vs. rental usage. For example, if you use your second home 30 days per year and rent it out for 120, it means 80% of your expenses are attributed to the rental, according to TurboTax.

For primary residences, joint owners can take $500,000 in profit tax-free when they sell their homes. But this tax break doesn’t apply to a second home. While you can turn your second home into your primary residence by living there for two years, you can’t otherwise avail the capital gains tax exemption.

Understanding Maintenance and Upkeep Costs

Second homes can have even higher maintenance and upkeep costs than primary residences because no one may be living in them for the entire year. If you own a second home, it may be located in a different state or otherwise be a far distance from your primary residence, so you may have to consider hiring a property manager to look after it.

In addition to that expense, you’ll have to make a budget for repairs and maintenance, and you should expect those costs to be higher than with your primary residence. Without someone in the house on a consistent basis, things may fall into disrepair more easily. If you have to travel a distance to manage things yourself, you’ll have to factor in that added cost of transportation as well.

If you’re renting out your second home, you’ll likely want to hire a rental manager as well. This type of manager can maximize your rental income, adjust rates based on seasonal trends, or even market your property. However, this service comes with a cost that you’ll have to factor into your budget.

Legal Considerations When Buying a Second Home

Generally, zoning laws and regulations are the same whether you are buying a primary residence or a second home. However, there may be some rental restrictions on your second home, depending on where you buy it. For example, some jurisdictions may only allow monthly rentals, not nightly rentals, and some may not allow certain rental services like Airbnb. All of this information must be disclosed before you make your purchase, so check with your realtor to ensure you don’t encounter any surprises.

Avoiding Common Mistakes

There are a few common mistakes that second-home buyers make that you’ll want to avoid:

• Overestimating rental income: If you’re planning to rent out your property to help pay off your mortgage, do some market research and find out what comparable homes in the area are renting for. Pie-in-the-sky projections could lead to financial problems down the road.

• Neglecting property maintenance: It’s just human nature to take better care of the primary residence that you live in rather than a vacation home you might only see a couple of times per year. But failing to maintain your property can damage its value, and perhaps even make it unrentable.

• Not planning for taxes: You can’t avoid capital gains tax if you sell your second home unless you make it your primary residence first.

Purchasing a second home can be an exciting adventure whether you’re looking to generate some additional income or simply want a place to vacation with your family. But a second home is also a big financial investment. Look at the potential financial return of your second home, both in terms of ongoing income and long-term capital appreciation and be sure you can afford not just the list price of your second home but also the ongoing expenses.

FAQ

• How much down payment is required for a second home loan?

  • A down payment of at least 10% is required on a second home loan.

• Can I deduct the mortgage interest on a second home I rent out?

  • You can potentially deduct your mortgage interest on a second home you rent out, but the math can get complicated and you might want to speak with a tax advisor. Generally, you can deduct the mortgage interest, but you might have to claim it on Schedule E rather than Schedule A.

• What are the tax implications if I sell my second home?

  • If you sell a second home, you’ll generally have to pay capital gains taxes on your profits. You cannot avail of the $500,000 tax exemption for joint filers ($250,000 for singles) who have held their property for at least two years.

• Should I buy a second home for vacation use or as a rental?

  • You should use your second home in any manner you see fit. If you prefer to use it as a holiday house, you don’t have to rent it out at all. But if you want to generate some income to help pay the mortgage, you may want to use it as a rental.

This article originally appeared on GOBankingRates.com: How To Buy a Second Home: Financing, Taxes, and More