Determine Your Risk Level Before Buying a Vacation Home
Many people living the American Dream of homeownership are moving to a second dream of owning a vacation home.
Vacation home sales rose 29.7 percent in 2013 to an estimated 717,000 from 553,000 in 2012, according to a recent survey by the National Association of Realtors.
Determining your level of risk in buying a vacation home, however, can take into account different factors than you would with an investment property, though a vacation home can be considered an investment too.
Most vacation home buyers weren't buying them as investments, however, but to use them for vacations or a family retreat, according to NAR. The survey found that 87 percent bought a vacation home to use for vacations, and 28 percent want to diversify their investments or saw a good investment opportunity.
Fewer people are buying second homes as investments. Purchases of investment properties for rental income, investment opportunities or related reasons dropped 8.5 percent to an estimated 1.1 million in 2013 from 1.21 million in 2012.
NAR's analysis if U.S. Census Bureau data shows there are 8 million vacation homes, 43.7 million investment units, and 74.7 million owner-occupied homes in the U.S.
Here are some factors to consider when determining your risk level before buying a vacation home:
Vacation homes cost more
If you can afford a second home, you should know going in that a vacation home is likely to cost more than an investment home.
The median price of a vacation home in 2013 was $168,700, up 12.5 percent from $150,000 in 2012. The median price of an investment home went up about as much, 13 percent, to $130,000 in 2013 from $115,000 in 2012.
This may be due to investment property prices dropping a lot in 2011 and 2012, and since them returning to normal market conditions, according to NAR.
Cash, large down payments the norm
While you don't have to have all cash or a large down payment to buy a second home, those were the norm last year and can make it a lot easier to qualify for a loan when you already have a mortgage on your primary home.
All-cash purchases were done by 38 percent of vacation home buyers and 46 percent of investment buyers in 2013, according to the NAR survey.
Of buyers who financed, large down payments were common. The median down payment for vacation home buyers was typically 30 percent, and 26 percent for investors, NAR found.
John O'Brien, a lawyer in Chicago, bought a vacation home 24 years ago about 150 yards from Lake Michigan near Michigan City, Ind., with all cash, in a roundabout way. O'Brien took out a mortgage on his primary home, which was paid off, to buy the vacation home so he wouldn't have a mortgage on it.
Vacation home buyers don't want to go into default on their mortgage, of course, and the best way to avoid that is to not have two mortgages, he says.
Add up all the costs
As you would before buying your primary home, all the costs of a vacation home should be taken into account before buying.
"Numbers never lie," says Yael Ishakis, a loan officer and vice president of First Meridian Mortgage in Brooklyn, N.Y. "I go over the proposed payment and include taxes and insurance and explain that is the new payment of the home."
"I always say, 'Forget about everything else, do you think you can afford to make this payment for the next 30 or so years?'" Ishakis says.
She also tells the borrower to find out the utility costs and other expenses such as garbage removal, lawn maintenance and cable TV.
If the proposed debt is 43 percent or less of a borrower's income, and they have good credit, assets and the appraisal comes through, then the loan should be approved, she says.
Buy the least expensive home
If you can't pay all cash, O'Brien recommends buying the least expensive home in the community where you want to vacation, as long as its livable. Having a low mortgage can decrease your risk level, so if you're able to make the home livable without serious repairs, then you'll save money.
"If you want to have a second home near the ocean, a lake, golf course or other vacation destination, and you're only going to use it part of the time, it doesn't have to be as nice as your primary home," O'Brien says.
Is it rentable?
Since vacation homes are often far from where you live on weekdays and you might not use it every weekend, your risk level can be reduced by buying a vacation home that can be rented out as a way to help pay for itself.
The typical vacation home is a median distance of 180 miles from the owner's primary residence, and 46 percent of vacation homes are within 100 miles, according to the NAR survey. Twenty-three percent of vacation home buyers plan to rent it to others, the survey found.
With that in mind, renting it for a week during the peak vacation season or for the entire off season can help bring in income, says O'Brien, who did that with his vacation home. The off season for his vacation home was September to June, when people needed temporary but relatively "long-term" housing, he says.
Can you afford to lose the vacation home?
Tyler Gray, a financial advisor at SageOak Financial in Tulsa, OK, says that for clients with a mortgage on their primary residence who are considering buying a vacation home, he recommends against it until their mortgage is paid off.
But Gray does make an exception to the rule, he says, if the owner can carry the mortgage and let the vacation property serve as collateral for the note.
"In other words, if you can no longer pay the mortgage, the lender will accept the property itself and any previous payments as 'payment in full' for the outstanding interest and principal on the note," Gray says.