Do you daydream about spending long, sunny afternoons in retirement, contemplating the waves as they roll onto the beach, just beyond the back patio of your vacation home? Or are you a mountain person who envisions a cozy cabin, tucked onto a forested hillside with a view of the valley below? For some, a second home that can offer opportunities for both restorative personal time and a venue for memory-making with children and grandchildren is a longed-for feature of the retirement lifestyle.
This, plus the remarkable runup in real estate values that happened during roughly the same period as the pandemic is probably part of the reason that the market for second homes has been red-hot, demonstrating 128% year-over-year growth between March 2020 and March 2021.
On the other hand, real estate prices, like other financial assets, don’t always go up, and the very real costs of owning and maintaining that second home require some careful calculation. Even for those who plan to rent the second home in order to recoup costs, there are expenses to be considered.
It’s important to remember, first, that second homes don’t receive the same type of consideration by lenders that primary homes do. Because they are viewed as more risky, mortgage interest rates for second homes tend to be higher (and in today’s environment of rising rates, that’s something to think about). It’s also not unusual for lenders to require a down payment of 20–25% for a second home, as compared with the 3.5% required for FHA primary home loans.
If, for example, you decide to purchase a $500,000 property, you’ll need to put down at least $100,000 to get started. If you get a 30-year fixed-rate mortgage at the current average interest rate of 6.231%, that puts your monthly principal and interest payment at $2,957; you can probably figure another $600–700 per month for taxes and insurance.
But the costs don’t end there. If you want to use the property to generate income, you’re probably going to need the services of a property manager who can help you advertise the property and deal with renters. Also, unless you live nearby and have good plumbing, electrical, and carpentry skills, you’re going to need someone to look after basic upkeep, just as you do with your primary home. A property management service is likely to charge 8–12% of monthly rental income, and perhaps a somewhat reduced fee if the house is vacant, depending on the particulars of your agreement. That typically doesn’t include the cost of any repairs or maintenance, which can run another 1–4% of the home’s value, each year, or anywhere from $5,000–$20,000 in our example.
Of course, you also have to consider the flipside: the property’s appreciation in value. Though real estate prices have cooled off from their recent blistering pace—largely due to the increased costs imposed by higher interest rates—real estate is likely to continue to rise in price for the long term, especially in the types of desirable areas where vacation homes would likely be situated. Especially for those in or approaching retirement who have a good understanding of real estate investing, this prospect can easily offset the expense considerations above. For those who don’t necessarily plan to pass the second home on to their children, the opportunity to reap a tidy profit—net of expenses—after five to ten years of ownership and enjoyment can make the picture even rosier. You will need to keep in mind, however, that the capital gains exemptions that apply to the sale of primary residences are not the same when selling a second home.
So, the bottom line for owning a second home in retirement, as with so many other important financial decisions, is that you need to crunch the numbers carefully. If owning that vacation retreat is integral to your desired retirement lifestyle, and if you’ve planned and saved so that the expenses won’t jeopardize your more important goals, then maybe vacation home ownership is for you.
At Empyrion Wealth Management, a part of Mercer Advisors, our fiduciary duty to our clients means that we provide guidance that is delivered with their best interests foremost. Whether that means helping you with a decision about a vacation home purchase, giving you access to needed resources for estate planning, or making smart choices for your retirement accounts, our goal is to help you get the information you need to make the choice that’s right for you. To learn more, click here to read our white paper, “Financial Planning Checklist for Retirement.”
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