Rates & Affordability

Read This Before Buying That Dream Vacation Home

If you're ready to get serious about buying a vacation home, consider these tips for buying a second home.

Take off the Rose-Tinted Glasses.

Vacations are meant to be relaxing. As you know from experience, home ownership isn't necessarily all margaritas at sunset. Carefully think through what you're signing up for if you no longer can leave all the maintenance nitty gritty to hotel staff or Airbnb hosts.

Consider Travel Time and Travel Costs.

According to the National Association of Realtors, vacation home owners travel a median of 200 miles to their getaway, and one third travel at least 500 miles. That's not a big deal for an annual vacation, but think through how much you would really use a vacation home that takes hours to get to. And if it involves a flight, tally that as well.

Upkeep Never Takes a Vacation.

You are probably going to need another pair of eyes to keep watch over your home when you aren't there. If you buy in a resort with homeowner association fees, that's an added cost, as is hiring a caretaker to swing by a home that's not in a development. You might also want to ask some local owners for a range of basic utility costs to get a sense of what it might run year-round.

Don't Forget Insurance Coverage and Costs.

Because you aren't living in the house on a consistent basis, the insurance premium might be more than you anticipate. And if you plan on living near the beach or a secluded mountain area where there is the threat of forest fires, you definitely want to price out what coverage is available before you start house hunting, and the cost. Knowing what the cost to protect a home might be is an important budget item, and might also help you focus on specific areas or types of homes.

Check out the Off-Season.

If your thought is that when you retire you will make your vacation home your primary residence, you might want to first spend an off-season as a renter to make sure you will enjoy going full-time. Northern snowbirds that flock to Florida and Arizona in the winter should make sure they are up for the summers.

Get Ready to Jump Through Higher Mortgage Hoops.

Last year, nearly three in four vacation home buyers used a mortgage to finance the purchase, and more than four in 10 said the process was more difficult than expected. Lenders that offer second-home mortgages know that if you ever run into financial difficulty, you would likely walk away from a second home before giving up your primary residence. That makes lenders extra caution when considering second home loans.

High Credit Scores Are a Must.

The stronger your credit score, the more likely a lender is going to see you as a reasonable risk. High Fico® Credit Scores also are extra important to have a shot at the best interest rate. The mortgage interest rate on a second-home purchase is typically higher than if the mortgage was for your primary residence. Coming to the table with FICO® Credit Scores of 740 or better can help you qualify for the best possible rate.

See: What is a Good Credit Score?

Make Bigger down Payments.

More than 70% of vacation home buyers in 2016 made a downpayment of at least 20%. Just 8% put down less than 10%.

Debt-To-Income Ratio Still Must Work.

You might remember this ratio from when you bought (or refinanced) your primary residence. Lenders want all your ongoing monthly debt payments to be around 36% to 40% or so of your monthly pre-tax income.

If you still have a primary mortgage, the monthly cost will be piled into this calculation along with the cost of the new mortgage you are seeking for the second home, along with other debts such as car loans and student loans. If your debt-to-income ratio is above 40%, you might still be able to qualify for a mortgage if you offer some offsetting positives, such as high credit scores and a large down payment.

Understand the Different Tax Rules

If your combined mortgage balances are below $1 million you can deduct the interest on your mortgage debt, as long as you don't rent out the home for more than 14 nights a year. If you rent out your place for fewer than 14 days a year, the rental income is tax free. If you plan on renting out your home more than 14 days a year, you should consider huddling with a tax pro. Once you pass the 14-day threshold the home is no longer a personal residence, but a rental property. You must report the rent as income. You also might qualify for some tax breaks beyond the mortgage interest deduction but the rules get as complicated as assembling one of the hardest IKEA items.

Property Tax Is Deductible.

There is no limit on the number of homes, or total property tax payments, that you can claim as a deduction. Keep an eye on Washington: an initial tax reform proposal would get rid of property tax deductions.

When You Sell, You May Owe Capital Gain Tax.

Federal tax law gives homeowners a big break when they sell their primary residence. Married couples that make up to $500,000 in profit when they sell their primary residence owe no tax. The exclusion is $250,000 for individuals. That does not apply to second homes. If you eventually sell at a profit you will owe federal capital gains tax. Most people fall into the 15% long-term capital gains tax rate. High-income households are taxed at a 20% rate.

That shouldn't be a deal breaker, after all, you only pay tax when you've made money. Moreover, you will have had years to enjoy your vacation getaway.