Buying a vacation home

Ideally, you might be ready if you've already paid off your first home mortgage.
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You might be ready to buy a second home if you've paid off your first mortgage

Americans own 7.5 million second homes, according to the most recent estimate from the National Association of Home Builders. But buying a vacation property is a huge decision and a serious financial commitment.

The financing can be tricky: Mortgage rates are higher than for first homes, a lender may demand a stronger credit score, and the loans often require a stiffer down payment — as much as 30%.

Given the hurdles, some real estate experts say don't buy a second home unless you can pay cash. That's what many people do: A 2020 survey from the National Association of Realtors found 49% of vacation homebuyers pay cash, vs. 19% of all homebuyers.

You do have another option, if you own your primary residence outright or have built up a healthy amount of home equity. You might tap into it to pay for your vacation home — or at least fund the down payment.

You can access your equity using a cash-out refinance of your first home, a home equity loan or a home equity line of credit (HELOC).

But note that under the 2017 tax law, you can't deduct the interest. The IRS says you get a deduction only if a loan used to buy a second home is secured by that home — not by your primary home. (Womp womp.)

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The benefits of owning a vacation home

If you rent out your vacation home, it can earn a passive income
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If you rent out your vacation home, it can earn a passive income

Having a vacation home can mean avoiding hotels, and spending less on vacation meals. You'll have your own kitchen for doing the cooking.

There may be other financial benefits, too.

Online vacation rental services such as Airbnb allow you to easily rent out your second home for weeks or months at a time when you're not using the place.

Your vacation property could become a steady source of income — especially if the house is close to a beach, ski hill or popular big city — and the rental income could help you pay off your loan faster.

You will have to pay tax on the income if you're renting out the place for more than 14 days out of the year, but you'll be able to deduct rental expenses including insurance, maintenance and utility bills, says the IRS.

A vacation home as an investment

A vacation home may grow in value, but it's not a guaranteed investment
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A vacation home may grow in value, but it's not a guaranteed investment

Thinking any vacation home is likely deliver a big, fat profit when it's time to sell? That depends largely on that ol' real estate mantra: location, location, location.

A waterfront home in Florida might always be in demand, while an off-the-grid cabin in the woods may have much more limited appeal.

But no matter where the place is, a vacation home should never be thought of as a guaranteed investment.

Properties intended for use as vacation homes, maybe in oceanfront communities or skiing meccas, will always be seen as luxuries. Meaning that if the economy slows down again, demand — and your ability to sell — could dry up overnight.

And consider whether any potential profit will be worth all of your costs, including ongoing maintenance, homeowners insurance and utilities. The place will be a year-round responsibility.

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Ready to pull the trigger?

Make saving a priority
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Make saving a priority

If you think you can handle the financial responsibility of a vacation home, make sure you're willing to revisit the same location again and again. If you already regularly vacation in a certain spot, buying a home there can be smart and enjoyable.

So, let's say you've weighed the pros and cons and have decided you do indeed want to become the owner of a vacation home. You'll need to make saving money a priority — so you can pull together the potentially hefty down payment.

According to Redfin, the median price paid for a home in a resort town during December was $408,000. If you find a place at that price and a lender requires 20% down, you'll need to come up with $81,600.

You'll also want to shop, shop, shop around for the lowest mortgage rate possible.

Don't settle for the first rate offer you get, no matter how good it seems. Studies from mortgage company Freddie Mac and others have found that a borrower can save thousands of dollars by gathering and comparing at least five rate quotes.

Before you know it, you'll be popping open the champagne and toasting your new vacation home.

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About the Author

Doug Whiteman

Doug Whiteman

Former Editor-in-Chief

Doug Whiteman was formerly the editor-in-chief of MoneyWise. He has been quoted by The Wall Street Journal, USA Today and CNBC.com and has been interviewed on Fox Business, CBS Radio and the syndicated TV show "First Business."

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