Know your budget before you buy a second home.
Home owners who purchase a second property do so for numerous reasons. Some want a vacation home that they rent out during the periods they’re living elsewhere. Others may buy an investment property to rent out full-time. A second house might be a place to eventually retire but can be rented out until its owners retire. Some generous parents might buy a home for a child. Finally, some people may end up owning a second home, (at least for a time), because they needed to move by a certain date and could not complete the sale of their first house by that date.
Here are some things to consider before purchasing a second home:
1. Are you a good candidate? Your monthly expenses, including the cost of the new home (mortgage, taxes, insurance), when added to current debt (mortgage, taxes, insurance, car loan if 10+ payments are still due, student loan, credit card debt) will typically be limited to no more than 36%-43% of your verifiable monthly income. This is known as your debt-to-income (DTI) ratio. If you do plan to rent out the property, speak to your mortgage banking firm about how the anticipated rental income can positively affect the calculation of your DTI.
2. Have you considered the cost of maintaining two properties? This includes immediate or eventual renovations such as roof and appliance replacements and painting. Will the second property involve new or additional fees pool maintenance, flood insurance, homeowners’ association fees)? Also consider the cost of a property management company to monitor and maintain the condition of the home in your absence, such as ongoing landscaping, snow removal, and checking for water leaks or frozen pipes in the winter. A mortgage services company like Ark can help you determine your MAP, or your monthly Maximum Affordable Payment.
3. Do you have a down payment (typically 10%-30%) that will still leave you cash to spend on any desired renovations plus an emergency fund in case of job loss or illness? You may consider refinancing your primary home to access any built-up equity to finance the down payment of the secondary property. Underwriters with mortgage lending companies typically want to see a buffer worth of six months of payments on both properties before approving your loan. Why? Investment properties can be subject to gaps in occupancy as well as tenant-inflicted damage. Regardless, the owner will still have to pay mortgage and taxes. Also, be aware that second homes may be subject to a higher mortgage interest rate. While this may affect you short-term, it may pay off in the long run at resale if and when the property appreciates in value.
4. It is critical that you obtain the advice of a tax advisor about the tax implications of purchasing, owning and reselling a second home, especially in light of new legislation that can affect deductibility and capital gains
5. Before buying a vacation home, you should decide if you might get bored of a location after a few years. Would a vacation rental be better suited to your needs?
6. If funds are tight, would you consider co-ownership of a vacation home with other family members or friends? If so, consult an attorney to set ground rules.
7. Choose the property carefully because if you decide at a later date that you don’t want two or more homes, you’ll want to make sure the home is easy to rent out or resell.