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Is a second home a smart investment?

Whether you’re thinking of it as a family gathering place or a long-term investment, here are key factors to consider now

 

HOME PRICES SOARED last year, in part because of the large number of second-home buyers looking for the perfect vacation home or investment property. In fact, by the end of 2021, demand for second homes was up 77% from pre-pandemic levels.1 But long before the pandemic drove people to search for comfortable retreats, the lure of the second home was a part of the American psyche.

“Unless you’re retired or can work remotely forever, consider a property that’s no more than a two- or three-hour drive from where you live.”

— Craig Venezia, author of Buying a Second Home: Income, Getaway or Retirement

 

We see it as a place where family can gather over the holidays or on vacations for years to come, where we might start setting down roots in a future retirement location. We also view a second home as a possible income generator as a rental, and we look to it as a way to diversify our investment assets, because property values generally aren’t tied to the stock market.

 

All of that makes sense. But before you start scanning real estate listings, it’s important to get a full picture of the potential costs, especially because low inventory has kept prices elevated in many vacation home markets, says Craig Venezia, author of the best-selling book Buying a Second Home: Income, Getaway or Retirement.

 

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The first step is to decide whether you’re planning to rent out the home at some point or keep it solely for personal use, says Kathryn Thompson, a Merrill financial advisor in Albuquerque, New Mexico. “That impacts everything from affordability to the choice of property. If you might live in the house permanently someday,” she adds, “be sure to visit the area during the off-season. Understand what Florida is like during hurricane season, for example, or what spring is like in Montana.”

 

If you’re buying it as a vacation home, Venezia says, ask yourself how often you plan to visit. A getaway to a remote lake can be wonderful — but will you grow tired of making the lengthy trek? “Unless you’re retired or can work remotely forever, consider a property that’s no more than a two- or three-hour drive from where you live.”

 

Whether you’re buying the home to rent out or for personal use, review the following questions with your advisor to see if this purchase might be a smart investment for you.

 

The costs of owning a second home.

How will you finance the purchase?

“Interest rates for second homes typically aren’t quite as low as they are for primary home mortgages, and you’ll likely need more than the standard 20% down payment,” says Marie Imundo, director, Wealth Management Mortgage Strategy and Execution, Bank of America.

 

You can write off mortgage interest on a second home loan — same as on a primary residence — up to a combined $750,000 for both residences.2

 

“Interest rates for second homes aren’t quite as low as they are for primary home mortgages, and you’ll likely need more than the standard 20% down payment.”

— Marie Imundo, Director, Wealth Management Mortgage Strategy and Execution, Bank of America

In a hot market, paying in cash can allow you to move swiftly to nab a home you want, so it might make sense to borrow against investments, using a Loan Management Account® (LMA® account) from Bank of America. “Ask your advisor to help you weigh the pros and cons of different financing options, as well as how the additional outlay might affect your progress to other important financial goals,” Thompson says.

 

What about ongoing expenses?

The purchase price of the house is just the starting point. You may want to do an extensive renovation before you move in. Besides the basics like furniture and kitchenware, you’ll also be on the hook for recurring expenses like insurance, energy, Wi-Fi and landscape care.

 

Talk to your financial advisor about what trade-offs you might need to make to afford these ongoing costs. Your advisor should also run the numbers on some worst-case scenarios, such as having to overhaul the septic tank or covering a steep rise in homeowners association fees. “I tell my clients that if they can easily afford those unexpected things, in addition to the cost of the property, and it doesn’t put a stress on their budget or put other, more essential goals at risk, then chances are they can afford the home,” Thompson says.

 

Turning the property into an income producer.

How much rental income can you expect?

You might assume that the best rentals are those near tourist attractions, but while those homes sometimes command a premium rate, they’re often limited by seasonality, says Venezia. Beach houses and ski chalets, for example, often bring in cash for only three to five months of the year. In his experience, some of the highest occupancy rates are for long-term rentals — for instance, ones that cater to visiting faculty in a college town. Talk to a local real estate agent about features that renters in the area typically want, such as parking or outdoor space.

 

How will you manage the property?

You may be able to deduct mortgage interest, property taxes, operating expenses, depreciation and repairs, depending on how you use your second home.

If you’ll be using an online home-sharing service or a local real estate agent, you can expect to pay up to 30% of your rental income to the company that brings your renters in the door, says Venezia. And keep in mind that renting to others means a lot more wear and tear, especially if you’ll have a stream of short-term renters coming and going. Expect to spend another 20% of your budget for repairs, he says, and consider hiring a property manager or local handyman to help with maintenance. The upkeep may be more than you want to manage yourself as you age.

 

What tax breaks might you get?

The IRS considers a property that is rented for 14 days or less each year as a personal home, and in that case you can’t take deductions on any expenses. If you intend to rent out the place for 15 days or more a year, your mortgage rate will be higher, says Imundo, and a higher down payment will likely be required.

 

You may be able to deduct mortgage interest, property taxes, operating expenses, depreciation and repairs, depending on how you use your second home. You can maximize those deductions if your own personal use of the property does not exceed 14 days per year, or 10% of the number of days the home was rented to others at a fair rental price, whichever is greater, notes Venezia. Also keep in mind that some cities and states charge a lodging tax for rental revenue earned within their jurisdictions. Talk to your financial advisor and tax professional about the rules that may apply to your situation.

 

One final tip: After considering all of the above with your advisor, consult your heart — and talk with family members. Doing your homework before purchasing a second home can help ensure that you’ll continue to view it as a benefit, not a financial burden.

“Demand for Vacation Homes Up 77% from Pre-Pandemic in December,” Redfin News, January 6, 2022.

 

“Home Mortgage Interest Deduction,” IRS Publication 936, irs.gov.

 

Bank of America, Merrill, their affiliates, and advisors do not provide legal, tax, or accounting advice. Clients should consult their legal and/or tax advisors before making any financial decisions.

 

The Loan Management Account® (LMA® account) is a demand line of credit provided by Bank of America, N.A., Member FDIC. Equal Opportunity Lender. The LMA account requires a brokerage account at Merrill Lynch, Pierce, Fenner & Smith Incorporated and sufficient eligible collateral to support a minimum credit facility size of $100,000. All securities are subject to credit approval and Bank of America, N.A. may change its collateral maintenance requirements at any time. Securities-based financing involves special risks and is not for everyone. When considering a securities-based loan, consideration should be given to individual requirements, portfolio composition and risk tolerance, as well as capital gains, portfolio performance expectations and investment time horizon. The securities or other assets in any collateral account may be sold to meet a collateral call without notice to the client, the client is not entitled to an extension of time on the collateral call and the client is not entitled to choose which securities or other assets will be sold. The client can lose more funds than deposited in such collateral account. The LMA account is uncommitted and Bank of America, N.A. may demand full repayment at any time. A complete description of the loan terms can be found within the LMA account agreement. Clients should consult their own independent tax and legal advisors. Some restrictions may apply to purpose loans and not all managed accounts are eligible as collateral. All applications for LMA accounts are subject to approval by Bank of America, N.A. For fixed-rate and term advances, principal payments made prior to the due date will be subject to a breakage fee.

 

Before taking out any mortgage or line of credit, borrowers should consult their tax advisor to understand the implications of each of their options.

 

Banking, mortgage and home equity products offered by Bank of America, N.A., and affiliated banks, Members FDIC and wholly owned subsidiaries of Bank of America Corporation.Home Icon for Equal Housing Lender Equal Housing Lender. Credit and collateral are subject to approval. Terms and conditions apply. This is not a commitment to lend. Programs, rates, terms and conditions are subject to change without notice.

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