Summer vacation season is in full swing. As you relax on your favorite beach, lake or mountain trail, you might think, “This is such a great place to visit. What if we lived here?”
Ian Katz, a real estate agent in New York City, sees more interest from retirees for second homes since the COVID-19 crisis. “The pandemic brought people closer. They want exposure to multiple climates while keeping in touch with family.”
Second home purchases have cooled significantly since 2020, mainly due to high mortgage interest rates. Nonetheless, says Katz, retirees and near-retirees are less likely to need large, long-term loans since many use their savings to buy a new property.
If you’re considering a second home, think carefully before making this major purchase. The wrong property can turn your dream into a nightmare. Here’s what you need to know about buying a second home in retirement:
1. Prices are around an all-time high
Even amid the overall real estate slump, homes in desirable vacation spots are still pricey. “Many towns now have full-time remote workers competing with retirees,” warns Katz.
Be conservative about budgeting, he says. Make sure you can keep up with your spending, including ongoing costs for the new home, even after a possible drop in income.
This significant commitment could restrict your ability to travel elsewhere, says Mark Charnet, a financial adviser in Pompton, N.J. “You’re tied to the same place. Unless you love the idea of having your own home and bed in each location, it might not be a good idea.” Maybe a hotel or renting homes through AirBnb or Vrbo is a better option for you.
2. Borrowing is more challenging
If you’d like to finance your purchase, mortgage rates are typically 0.5% to 0.75% percentage points higher for a second home versus a primary home. And if you do have to borrow, mortgage rates are the highest they’ve been in 20 years.
You should also expect to make a down payment of at least 10% on a conventional mortgage for a second home, though a larger down payment could give you a better chance of qualifying for a lower interest rate, says Katz.
3. A test drive leads to a smarter purchase
Katz has seen retirees rush second home purchases without genuinely understanding the area they’re buying in, which can lead to regrets. “Get a hotel or Airbnb for an extended stay first,” he says. “Sample the daily vibe.”
Consider how a property would meet your long-term retirement needs. “Even if you run marathons today, that might not be the case 20 years from now,” says Katz. Think of how you’d manage around a property with less mobility. How many steps are needed to get inside from your car? Is the bedroom on the ground floor? Katz says to check whether the local homeowners association would let you make mobility upgrades like a wheelchair ramp.
4. Upkeep and maintenance add up
Charnet finds that people underestimate how much they’ll owe in annual upkeep and maintenance on a second property. “They budget for the mortgage and the taxes, but that’s just scratching the surface,” he says. “Any given year, the windows might need to be replaced, the roof could leak or the water heater could break.”
Depending on the age of the house, maintenance expenses may shock you. A newer place may require only 1% to 4% of the home value for maintenance and emergency repairs, but an older place can cost much more. Charnet, who owns 25 rental properties, sets aside 7% a year for maintenance and emergency repairs. On a $300,000 property, that would be $21,000 a year.
5. Property taxes can be a nasty surprise
States such as Florida, Nevada and Texas don’t have income taxes, but they can really stick it to you with property taxes. Katz, the real estate agent from New York City, says to check how the property tax bill will be assessed after you buy. Some localities readjust based on the new selling price.
“Let’s say you buy a place in Delray Beach, Fla., from someone who bought it 20 years ago,” he explains. “That old price will anchor their property tax. When you take over, the taxes will end up much higher than what it currently says on Zillow.”
6. State income taxes depend on the 183 day rule
Buying your second home in another low- or no-income tax state could be a way to lower your overall tax bill. But it depends on how long you live in your second home.
New York and many other state governments follow something called the 183-day rule. Florida is a popular second-home location for people from high-tax New York, but if you spend more than 183 days in New York during the year, it counts you as a resident for taxes.
7. Renting is possible, but not always easy
As you move between locations, you could potentially rent out your unused properties to generate extra income. Tim Touchette, owner of Attache Corporate Housing in Washington D.C., runs these arrangements for retirees but says short-term renting can be challenging, as leases are typically a year or longer. “If you’re away for six months, the problem is you need to find a renter looking to stay exactly six months.” Or it could mean juggling multiple renters throughout the year.
Renting means overseeing the property yourself as a part-time landlord or paying out-of-pocket for a property manager, which costs about 8% to 12% of the monthly rent. Touchette says people typically expect to have furnished properties for short-term rentals. You might not love the idea of others using your bed, couch, and other belongings.
Before buying a condo, check whether the building has rules and restrictions limiting your ability to rent.
8. Tax breaks depend on usage
You can deduct the home mortgage interest and property taxes for a second home against your personal income, the same as you do with your primary residence. To qualify for these tax breaks, you must live in the property at least 14 days a year or 10% of the days you rent it out, whichever is greater.
You can rent out a second home for up to 14 days per year without owing income taxes. If you rent for longer, you’ll owe income tax on the rental income, but you’ll qualify for more tax breaks, such as the cost of repairs to the property, maintenance, insurance and hiring a property manager.
When you sell your second home for a profit, you owe taxes on your entire gain. There isn’t an exclusion like for selling your primary residence. As long as you own the home for at least one year, you owe long-term capital gains which is much lower than the income tax rate.
9. Insurance and an LLC protect your investment
You will need a homeowner’s insurance policy on your secondary home. Charnet, the financial advisor from New Jersey, says your existing carrier may allow you to expand your current policy to cover a second home, but he suggests getting quotes from local insurers in the new area. “It could be less expensive to buy from an agency that understands the other market versus your current carrier.”
If you plan on renting out your second home, Charnet suggests setting up a limited liability corporation (LLC) to own the property. “When you own both properties outright, and someone sues for an injury, they could also come after your primary residence and savings. If an LLC owns the second home, the most they can get is the value of the second home.”
10. Inherited properties aren’t always welcome
Vacation homes are a top asset for inheritance fights, especially if some heirs want to keep the property and others want to sell. “If you have three kids, are they all interested in that vacation home?” asks Charnet. “If not, you could split your estate so the ones who aren’t interested receive more cash, investments, or life insurance payouts.”