Craig Venezia is writer for the San Francisco Chronicle and author of Buying a Second Home: Income, Getaway or Retirement. On March 6, 2015, Craig published “The Dollars and Sense of Buying a Vacation Home” and provides some insight into what it means to own a vacation home. As with any investment be sure to do your due diligence and understand the implications of the investment as they apply to the state in which the property exists.
According to the National Association of Realtors, Americans bought 717,000 vacation homes in 2013. If you’re considering taking the plunge, take time to figure out what a vacation home purchase would really cost you. Otherwise, you may find that owning one is no holiday.
Expect Stricter Mortgage Requirements
More than 60 percent of vacation-home buyers carry a mortgage (current national average rate: 3.5 percent on a 30-year fixed-rate loan). If you plan to get one, be prepared for more scrutiny from lenders than on primary residences.
“These loans tend to have higher credit requirements because people are taking on large amounts of additional debt,” says David Gorman, Regional Sales Executive for Bank of America. “Traditionally, they are more likely to pay the mortgage on their primary homes if they run into financial issues.”
Those higher credit requirements come primarily in the form of higher down payments. Expect to put down at least 10 percent on a vacation home (compared to a 5 percent minimum, or even no down payment, for a primary residence). You may want to put down 20 percent or more, if you can, to avoid paying private mortgage insurance (PMI), which usually runs between 1/2 and 1 percent of the loan amount on an annual basis.
You’ll qualify for the best mortgage rate if your credit score is over 700. Otherwise, you could pay a rate that’s about one percent or more higher.
Know the Cost of Insurance
You’ll, of course, need homeowner’s insurance and you may have to buy flood or earthquake insurance.
According to the Insurance Information Institute, if you plan to use your vacation home exclusively for yourself, insuring it may be as simple as extending the policy you already have on your primary residence.
If you’ll be renting it out, though, you’ll need to buy a separate rental dwelling policy; that costs about 25 percent more than your primary home’s policy. Most rental dwelling policies reimburse for the loss of rental income if you can’t rent your place out while it’s being repaired due to damage from a covered loss.
Since owning a vacation home means you won’t be there all the time, you may need to hire someone to take care of it during your absences — or when you’re in between guests, if you rent it out.
For townhouses or condominiums, you homeowner’s association dues will handle outside maintenance. No such luck for single-family homes. Regardless, the inside is your responsibility.
A property management company fee can vary depending on the level of services. The management firm can also help you find short term guests or long term renters if you want; expect to pay upwards of 20 percent or more on the daily rent you take in.
Understand Tax Implications
Be sure you’re familiar with the vacation home tax rules, too, before making a purchase. The property will still qualify for the mortgage interest deduction, assuming the combined mortgages on both your homes don’t exceed $1.1 million. And property taxes are fully deductible.
Things get trickier, taxwise, when you use the vacation home as a rental property. “If you rent out your vacation home for more than 14 days a year, you will have to report rental income,” says Jared Callister, a tax attorney in Fresno, Calif. “But you will also be able to deduct rental expenses, like repairs and depreciation.”
What you can deduct depends on how much you use the place personally versus renting it out. Also, most states expect you to pay sales taxes on rental income.
Some cities and counties impose such taxes, too; they may go by other names, such as lodging,accommodations, hotel, bed, tourist or transient occupancy taxes. Be sure to find out whether you’d owe them so you’re not hit with a nasty surprise after you become a vacation-home owner.
In Hawaii, all property owners are required to pay property taxes. If the property is rented, long term rental income (greater than six month lease) is also subject to General Excise Tax. While short term (vacation) rentals are subject to both General Excise Tax and Transient Accommodations Tax. As with all Hawaii income, the income is subject to income tax.
But wait there’s more, Hawaii may impose other taxes when it comes time to sell the property. For more information on taxes, you should consult a local accountant.
Bottom line, even with the management fees, insurance, and taxes, the right deal combined with the right management company, over time, can get you positive return on your real property investment. Just be sure to do your due diligence.