Vacation Home Buying Guide
Second-home sales exploded in recent years due to low-interest mortgages and soaring demand from Baby Boomers. Rising mortgage rates slowed sales in 2006, yet the wave of Boomers enriched by their offspring leaving the nest continues
Since seven in 10 Americans now are home owners, the American Dream is no longer owning a home but buying a great escape vacation property, be it an oceanfront condo, a lakeside cabin or a ski-resort chalet.
Second-home sales exploded in recent years due to low-interest mortgages and soaring demand from Baby Boomers. Rising mortgage rates slowed sales in 2006, yet the wave of Boomers enriched by their offspring leaving the nest continues to swell and it's expected more than 30 million Americans will buy a vacation home within the next decade.
The considerations in shopping for a vacation home – from determining what you can afford to getting a home inspection – are the same as for a primary residence. Yet there a numerous other factors in buying a vacation property that have a major bearing on its soundness as an investment and its owner’s future enjoyment.
First and foremost, how much use do you really expect to get out of the property? If you’ll only spend one week and every sixth weekend there each year, you may be better off just renting yourself, especially with the availability of inexpensive vacation-rental properties via Web sites like vrbo.com and cyberrentals.com.
Next, how large a vacation home do you really need? Since this is a place to escape and relax, consider comfort over spaciousness to keep upkeep and maintenance to a minimum. If you’re looking to accommodate a young family of four or more and anticipate having frequent guests, you’ll want enough space to avoid feeling cramped during your R&R getaways.
Finally, how long do you expect to own this property? If you’re an empty-nester planning to move into the home in retirement, a cozy two-bedroom cabin or condo with a master bedroom and home office/guest room may well suit your needs. If you foresee your adult children’s families coming to visit often, a third bedroom and large living room that can accommodate two sleeper sofas will spare you getting overwhelmed by your loved ones’ arrival.
How much time and cost it takes to get to your vacation property has a huge bearing on how much you’ll enjoy and use it.
Just like suburbanization pushed our primary residences farther into the hinterlands, soaring demand for desirable, nearby resort areas has sent Americans farther afield for affordable vacation properties. According to the National Association of Realtors, vacation-home owners now live an average of 220 miles from their properties, and a third live more than 500 miles away.
In general, a drive of two hours or less is ideal and three hours is within reason. Just don’t mistake mileage distance for drive time; weekend-getaway escape routes often get backed up on Friday evenings and Sunday afternoons.
Employers increasing willingness to allow for telecommuting a day or two a week is expanding the geographic reach for buyers. A three-and-a-half hour drive is easily tolerable if you can stay at your mountain cabin three or even four days rather than just a weekend. For that reason, investigate the availability of high-speed Internet access in your desired area.
As for more distant locales, be sure to factor in the cost of airfares during peak season not just the off-season. You could opt to buy something in the Sunbelt if off-season fares are cheap and you don’t have to fly a family of five there each time, then rent it out for top dollar during the high season. It limits your usage but stretches your geographic possibilities.
Regardless of your means of transportation, as a general rule, you want to be within three hours of a major metropolitan area and an hour’s drive from a large airport.
The mantra “location, location, location” applies as much to a vacation home as it does to a primary residence and even more so if you need to rent it out to offset your costs. You may not mind being three blocks from the beach, but your rental prospects will be much better within one block, as will your resale value. If the prices are the same, you’re better off buying a fixer-upper close to the water or ski slopes than the new condo farther away.
Next, does the area have all the amenities you’d want? You may be smitten by its natural beauty, but consider what it offers in terms of recreational activities. Escaping from a stressed workweek to your mountaintop vista is great, but you may soon tire of holing up there with nothing to do but read a good book and admire nature. An A-frame in remote woodlands also may quickly bore today’s video-game generation kids. If you plan to keep the property into retirement and possibly retire there full-time, you may ultimately find it too secluded then, too.
Whether the home is in an older, established resort area or an up-and-coming one heavily touted by developers is a major factor in the security of your investment. Older resort towns are a safer bet since they have proven appeal. The latter could be a better investment if the community takes off -- or it could be a bust that resigns you to vacationing in an underdeveloped area lacking many key services and amenities.
Don’t buy into some Realtors’ hype that their sleepy burg is on its way to becoming the next Aspen or Palm Beach and you have an opportunity to get in early. Resort developments are notorious for getting shelved or abandoned altogether at the slightest whiff of an economic downturn. If you chose to buy in a newer community, stick with large, established developers and investigate their track records on both appreciation history and construction quality.
Taxes, health care and climate
Be sure to investigate cost-of-living and local taxes – especially income taxes if the home is in another state. Countless retiring Boomers are having to abandon relocation plans upon discovering the state tax bite on their fixed income will be worse than where they now live. Bear in mind some states offer income and property tax breaks for seniors that could ease that tax burden.
Even if you don’t plan on renting your property, avoid municipalities that prohibit short-term rentals in certain areas, and homeowner or condo associations that do likewise. Your personal or financial needs may change in the future and you don’t want your options restricted.
If you might move into your vacation home in retirement, you’ll also want to research the quality of health care and assisted-living facilities in the region. Is there a large regional or university hospital within an hour’s drive? Many resort areas lack specialized physicians, which forces seniors with serious health problems to sell the charming waterfront home they took a lifetime to acquire and move back into a congested metropolitan area to get routine treatment.
Lastly, will the area’s year-around climate suit you? A three-hour drive south in the winter gets many Americans into milder weather. Consider calling a government meteorologist’s office to inquire about the best microclimates in a given area, especially on the West Coast, that could offer a pocket of sunnier or drier weather.
Despite lenders’ recent easing of mortgage qualifications, getting a loan on a vacation property is still tougher than for a first home since, in a poor economy, borrowers are more likely to default on a second-home mortgage than on their primary one. As a result, you may have to put up a larger down-payment and pay a higher interest rate, perhaps a half to a full percentage point.
Many homeowners are using the equity in their first home for a down-payment on their vacation home, and even to buy the property outright. If you can afford to go that route, stick with a fixed-rate home-equity loan rather than a line of credit with a variable rate that rises with each Federal Reserve Bank rate hike. You can refinance in the future if mortgage rates drop.
Consider also getting pre-approved for the mortgage amount you know you can afford to keep within your ideal price range. Avoid taking an interest-only loan to squeeze into the most expensive house you can; that’s risky enough on a first-home purchase and sheer foolishness on a second-home. If you take out an adjustable-rate loan, keep the fixed term to a minimum of five years. Sizeable upward adjustments in your payment could force you into renting out a property you’d hoped to keep for yourself.
Income tax breaks
Federal law grants mortgage-interest deductions on second homes as well as primary residences, which is something to factor into your cost of ownership.
Additionally, many empty nesters are downsizing their primary residences and using their capital gain to buy a vacation property, in essence getting two homes for the price of one. Home sellers can keep up to $500,000 profit on a home sale tax-free, which buys a desirable home in almost any resort area and a luxurious one in many.
Additionally, if that same couple wants to rent out their primary residence and move into their vacation property full-time for two years in any five-year period, they could then sell the vacation property and pocket another tax-free gain of up to $500,000.
Like condominiums, vacation home prices tend to lag overall real-estate market swings, falling faster and farther in slowing markets and increasing more slowly in rising ones. For that reason, it may be wise to wait to buy – or not – depending on the current market environment.
Avoid buying in peak season and shop in the off-season instead. Just as first-home prices tend to soften after Labor Day when few families with school-age kids are shopping, vacation home buyers have a lot more negotiating strength when the tourists have packed their bags and left.
Be sure to investigate recent comparable sales diligently. Since many people buy vacation homes on impulse and emotion -- and frequently overpay as a result -- “comps” tend to vary more than in urban and suburban markets. Base your asking price on the least expensive comp you can find.
In a weakening housing market, it also could pay to look for bank foreclosures and FHA/VA repossessions. The default rate on second homes is generally higher than on primary residences, which people strive to hold onto for obvious reasons. These may not be pristine or ideally located properties, but they could be real bargains.
Be sure to gauge construction quality and stick with solidly built homes. Many older vacation homes were built on the cheap, and many still are. That funky little bungalow may have tons of character, but it may not stand up well when left unattended for long stretches or abused by six college-student renters on summer break.
As with a primary residence, buy the cheapest house in the best neighborhood. If the home itself is small, consider the add-ons possibilities. That’s especially wise for people who may move into their vacation home in retirement and can use equity from their primary-home sale to finance expansion and remodeling projects. Just be sure you won’t end up with the costliest house in the neighborhood once you make those improvements.
And don’t make the mistake many do -- buying a property they glimpse in some realty-office window ad during their first brief visit to a resort town. Return home and do extensive research on the area and the local real-estate market. Then go back for at least two more stays – you may find the appeal fleeting and avoid suffering buyers’ remorse. Is this really the one spot on earth you’d like to return to, over and over, in what little spare time you have?
If you do need to rent to cover part or all of your mortgage, there are several considerations.
The ideal situation is to be “cash-flow positive” so that your rental income covers all your costs. The recent spike in vacation home prices has made that tough to do in almost all vacation-home markets, especially if you don’t handle the rentals yourself, from bookings to contracting for housekeeping services. If you opt to use a property-management firm, you’ll pay up to 50 percent of your rental income in fees.
If your property is in a popular area, the best you can generally hope to get is about 12 weeks of rentals during peak season and immediately before and after. Expect to receive no more than 75 percent of your peak-season rate in the “shoulder” seasons – late spring and early fall for summer resorts -- and only 25 to 50 percent in the off-season.
If you plan on renting for any period of time, look for features that most vacation renters want: a minimum of three bedrooms, an eat-in kitchen with dishwasher, and room for sleeper sofas to stretch your maximum occupancy to accommodate two families staying together. As mentioned earlier, the biggest attraction to renters is prime location within the resort community.
Beware this catch: If you rent the property more than two weeks a year, you lose your second-home mortgage-interest tax deduction. You’ll instead have to treat the property as an investment for tax purposes.
Finally, if you’ve found an area you’re certain you love, you may elect to buy a piece of land and build your dream vacation home now or some time in the future.
Many Boomers have been taking advantage of a federal tax-law loophole that lets them take a tax deduction on a raw land purchase, which is otherwise verboten. Homeowners are allowed to borrow up to $100,000 on their primary residence for any use and deduct the interest payments off their regular income. It’s unwise to employ this strategy to speculate in land deals – an extremely volatile market – but a smart financial-planning move if you plan to build your own home on the lot or acreage down the road.
Lastly, look for subdivisions with the tightest, restrictive covenants that suit your needs and budget, such as minimum building sizes and bans on tree-cutting and or parking RVs on the property. Along with preventing your neighbor from plunking down a ratty old mobile home next door, a common occurence in modest, unrestricted resort-area subdivisions, your property will be more valuable as a rental or for resale.