Many people dream of owning a second home. But it's a costly dream. If your home is the most expensive purchase you'll make in your life, it stands to reason a second home will be the second most costly.
So you obviously want to do what you can to make it as affordable as possible. With that in mind, here are four tips for buying a second home that can help make your dream a reality.
1. Leverage equity
If you've accumulated equity in your primary residence, a home equity loan or cash-out refinance are attractive options for buying a second home. For one thing, they're often easier to qualify for than a mortgage on a vacation property, so it helps simplify the process.
If you're thinking of using it as an income property, at least part of the time, financing a vacation home through home equity borrowing means you don't have to worry about documenting potential rent income to justify the loan.
Home equity loan rates are typically higher than mortgage rates on a primary residence, but so are mortgage rates on second homes, particularly those deemed to be investment properties. And if you opt for a home equity line of credit (HELOC), you may be able to treat it as an interest-only loan for the duration of the draw period (usually 5-10 years), giving you payment flexibility during that time. HELOCs often allow you to minimize or even eliminate loan origination costs as well.
You can also take a mortgage interest tax deduction on up to $100,000 in home equity debt for a married couple filing jointly, which works well for a modest getaway home. However, if you want to take a tax deduction on a larger amount than that, you need to finance the second home as its own mortgage.
The reason? While a couple can take a tax deduction on the interest paid on up to $1 million in mortgage debt for the acquisition of a first and second home, that debt must be secured by those homes. With a home equity loan, the debt is secured by the first home, not the second, so the $100,000 cap for home equity debt applies. The $100,000 cap also applies to money taken out of a cash-out refinance for non-home improvement purposes on the primary residence.
2. Find the right location
Another key bit of advice for buying a vacation home is to choose a property you'll definitely use, one that's in an area you enjoy but not one so far away that you'll never visit it. Location becomes especially important if you use the property as a rental for extra income, because it will be easier to check on tenants and perform routine maintenance.
If you buy a second home within 50 miles of your primary residence, lenders will treat it as an investment property regardless of whether you plan to use it that way or not. So if you're not using a home equity loan to fund the purchase, as described above, you'll want to find one at least that far away.
Consider too, the type of lifestyle you want at your second home. A condo at a resort can offer access to an active social life with many of the routine maintenance needs taken care of, but may not provide the atmosphere you seek. A cabin in the woods or on a lake may offer peace and solitude, but could also require that you spend much of your getaway time on maintenance.
3. Consider a fixer-upper
Rather than buying someone else's idea of a dream vacation home, consider creating your own. A less-than-perfect property can quickly pay for itself if you use home improvement loans to update it, and you'll have the satisfaction of remodeling or upgrading your second home to suit yourself.
If you go this route, be sure to have a thorough professional inspection of the property, beyond what's called for in the usual purchase inspection. You want a good idea of what the fix-up will actually cost and what it will actually involve. Check the zoning and association rules as well. Some associations have strict rules about what you can and cannot do in terms of altering the appearance of old cottages, or there may environmental restrictions on new construction, particularly in dune areas.
4. Mix business with pleasure
Many investors combine their use of a second home as a vacation getaway with an occasional lease or rental. Not only will you make money by leasing, you'll save money by not paying for lodging at vacation time.
The IRS considers a second or vacation home an investment property if you use it for less than 14 days a year or 10 percent of the time it is occupied, whichever is less. That means you can deduct many of the costs of operation, including mortgage interest and maintenance. You can still deduct some costs if you only rent it out part of the year, but on a pro-rated basis.
If you act now, while the buyer's market is still hot and overextended sellers are desperate, you can possibly acquire an undervalued second home at a discounted price. By using a home equity loan to finance it, you'll leverage your money in two ways. The existing value in your primary home can help acquire a long-term investment with built-in profit (and holiday pleasure) potential.
(Updated July 2017)