Is a Second Home a Good Investment? 7 Things to Consider

Real estate continues to increase in value year over year. If you’re exploring options to diversify your portfolio, you may be thinking of buying a second home as an investment – to flip, to use as a vacation home, to begin transitioning to for retirement or to use as a rental. Before you start hitting those open houses, here are some things to keep in mind. 

What to Consider Before Investing in a Second Property

Securing a Second Mortgage

Financing a second home typically involves more than getting a mortgage on your primary home. In many cases, you’ll need more for a down payment and you’ll get a higher interest rate. You’ll also have closing costs. To fund a second home purchase, you may be able to get a home equity loan or cash-out refinance your current home, but carefully consider what each option means for your finances long-term. 

Double Ongoing Expenses

Double the houses means double the routine expenses. When you calculate the cost of a second home, keep in mind that you will be responsible for property taxes, homeowner’s insurance, utility costs and potentially HOA fees on a regular basis. Not to mention you’ll have to cough up for regular maintenance and unexpected repairs. 

Renting Out a Second Home

Before you jump into the world of rental properties, take a close look at the laws and regulations in the state, city and even community you’re looking to purchase in. Some have strict rules that prevent certain kinds of rentals (such as short-term vacation rentals). 

If you’re looking to utilize the home for short-term rentals, you should be sure you can balance when you want to be in the home with when you want to rent it out; when you want to utilize the home may be peak time for vacationers. You may also have additional regular costs, such as marketing and cleaning services. 

Whether you’re looking at renting the home as a vacation spot or a primary residence for someone, you’ll have to consider if the rental income you can get will offset the costs of owning the property. You may have higher insurance costs because you have increased liability. You may also consider hiring a property manager or property management company, especially if your primary residence is some distance away. 

Flipping and Selling a Second Property

If you have construction and renovation experience, you may be considering buying a second home to update and resell. While it’s true that updated homes sell for more, consider how much the market values these home improvements versus the actual cost of a renovation. Home improvement is often more expensive than anticipated, and you want to ensure that larger or riskier projects are completed by qualified professionals so you can ensure there will be no issues when the home inspector comes around. 

Maintaining a Vacation Home

You want a cozy place for your family to spend time together, somewhere you can settle in and feel at home when you want to get away from your regular life. Keeping a second home as strictly a vacation home is a bit more complicated than finding the right home and purchasing it, and the decision to do so includes some nuances, as well. 

In order for it to be considered a residence, the IRS dictates that you have to live in the home for 14 days each year or 10% of the total days you rent it to others. You’ll have to plan appropriately for travel.

You may also have to set aside a significant amount of money. Not only do you have no income stream from rentals or lump sum from a sale, but you also have increased costs. Typically, your insurance rates will be higher on a vacation home because there are long periods when it is unoccupied. You may also want to invest in a robust security system to protect the property while you’re at your primary home. Consider also that you may need to furnish and outfit your vacation home. Unless you plan on bringing necessities like dishes, towels and cleaning supplies with you each visit, these extra expenses can add up quickly. 

Tax Implications

Buying a second home impacts your tax liability. If the property is a true second home (not a rental), you can deduct the mortgage interest you pay on a total of $750,000 of debt across both homes. You can also deduct property taxes, but the total of all the state and local taxes you deduct – including property and income tax – is restricted to $10,000 per tax return. 

If you have an income-generating property that you rent for more than 14 days throughout the year, you can deduct expenses, such as mortgage interest, real estate taxes, maintenance, utilities, insurance and depreciation from your rental income. 

Before you invest in a second home, talk with a tax advisor about how you intend to use the property and what the tax implications of that decision are. 

Your Future Financial Situation

You may think purchasing a property will be a smart investment decision, but you need to know when to buy a second home without putting your financial future at risk. Put together a budget that includes the purchasing costs and all the ongoing expenses. Take a few months to put that amount of money in a separate account or allocate it to your primary mortgage; if you are stretched financially, consider changing your plan.

Also keep in mind that if you plan to rent or flip the property, you may face a stretch where your income dreams aren’t coming to fruition. Consider what it would do to your finances to have a stretch when you don’t have renters or if you can’t sell the home as quickly as you’d like. 

Tips for Buying a Second Home

Build an Emergency Fund

If you’re thinking about purchasing a second home, start building a robust emergency fund. With increased regular expenses plus twice the risk of something expensive popping up – like a water heater that needs to be replaced in your primary home at the same time as the fridge breaks down in your second home – you’ll want to have a pot of money set aside. Consider also that an ideal emergency fund covers 3-6 months of expenses; with a second home, that monthly expense number goes up significantly. Make sure you can continue to save while paying for that second property.

Do Your Research

Make sure that a second home is a good investment. What do property values look like and how have they moved in recent years? Is it in a popular area? Can you use the property for the use you’re intending? What is the travel like between your primary residence and your secondary home? Does this area/community offer what I’m looking for? 

Work with a Professional

Before you make a decision, work with a financial advisor and a tax professional to determine if this buying a second home is a smart choice for you at this time. If you determine that it is, work with a real estate agent to find a property that meets your needs and your budget. 

Connect with a Farm Bureau agent or financial advisor in your area. 

^{Neither the company nor its advisors or agents give tax, accounting, or legal advice. Please consult your professional advisors in these areas.}