Owning a second home can be a smart investment as you get older. It can provide a source of passive income, giving you extra money well into retirement. Many people buy a second home knowing that it’s where they’ll eventually retire, and getting it early means more time to enjoy it.
No matter what motivates you to consider a second home — and how it plays into your future plans — there are a few ways to make the large purchase more affordable.
Step 1: Figure out your budget
Before looking at any listings online, you need to ask yourself if you can afford a second home. Since you’re working with mostly known costs, it’s easy to calculate a precise answer. These include your income, savings, what you have for a down payment and how much you could afford for a monthly mortgage.
Even if you don’t currently work off a budget, it’s “extremely important to know what your income and expenses are in your current financial situation” Micah Frankel, Wealth Management Director at Precision Wealth in Irvine, California told The Atlanta Journal-Constitution. This informs you if you have the extra funds to afford to own a second home.
Once you have all your current numbers laid out, you can apply the set costs of homeownership into your budget to see if they fit. Frankel said those expenses include:
- Upfront, one-time expenses like the down payment and any initial property improvements.
- Ongoing expenses like mortgage payments, utilities, insurance and HOA fees.
- Emergency expenses like unforeseen property repairs which can include roof damage, a tree falling and anything else that could happen and be costly.
In today’s real estate market, you’ll need to have at least a 10% down payment ready if you’re going to buy a second home, though 20% is preferred, according to Wes Woodruff, Partner and Mortgage Loan Originator at Residential Funding Consultants.
You’ll also need to factor in today’s interest rates, which are currently on the higher side. As of April 2022, they’re in the low-to-middle 5% range, Woodruff said.
Pooling all this information together, you’ll end up with a working document that answers whether you can afford a second home.
Step 2: Get pre-approved for a mortgage
Once you verify that you can afford to own a second home, the next step is to get a mortgage pre-approval.
“Obtaining a mortgage loan in your retirement may be more difficult than when you have income from employment,” Frankel said. “But lenders can typically take into consideration income from retirement accounts or other income-producing assets.”
Starting here is really the next necessary step to avoid disappointment, Woodruff said. Crunching numbers ensures you’re only looking at properties you can truly afford rather than finding your dream second home and realizing it’s out of your budget.
“Finding a house you like first can lead to disappointment and make it harder to come down to the realistic sweet spot,” Woodruff said.
However, it’s worth considering different types of mortgages for your second home. You don’t have to treat it like your primary residence, where you may want the predictability of a fixed-rate mortgage with the same monthly payment for 30 years. It may be more affordable to think about your second home mortgage differently.
Woodruff recommends looking into other options and considering an adjustable-rate mortgage. ARMs are popular today because they offer a lower monthly rate for a set number of years, typically around eight. This loan type previously suffered from a bad reputation because of the real estate crash of 2008 but it fits better in today’s market. The lower interest rate ARMs offer could make the property more affordable upfront. Then, at the end of the cheaper period, if the payments go up too high, you can refinance into a fixed mortgage for more stability.
Step 3: Pick the right place
Knowing your budget and what the bank will let you put down means you can begin narrowing down your choices for the location of your second home.
Will this property simply be somewhere you take the grandkids? If so, it should be near family-friendly activities. Will this home be where you ultimately retire? If so, it needs to have plenty of amenities to make life comfortable. Do you want to live near the beach, in the mountains, close to an airport? Ask yourself all of these types of questions to narrow down locations. Then, compare prices to find your ideal destination.
Recent changes to Fannie Mae guidelines require you to occupy the property for at least 14 days per year for it be considered a second home, according to Woodruff. For the rest of the year, you can use the property however you want, but it needs to be accessible enough to meet this minimum requirement. You may want to only look at places within a six-hour drive or a two-hour flight. You may want something closer so it’s easy to hop in the car on a Friday and visit for a weekend. Easy travel will likely factor into this decision.
Step 4: Find a local agent
Chalon Kaley, a Realtor with Berkshire Hathaway HomeServices Georgia Properties, suggests finding a reputable agent that works in your chosen area, even if they’re not someone you’ve worked with before.
“A true second home will likely be in a location homebuyers might not be very family with,” she said.
Picking an agent who knows the area and can help you efficiently shop within your price range is hugely important.
Kaley suggests you reach out to your local agent for a vetted referral if it’s overwhelming to start your agent search from scratch in a new city.
Having a local agent means you get more information on the local community. They can help you find the best neighborhoods and may get insight into properties before they hit the market. They can also provide you with targeted search results online so you’re not looking at properties that would ultimately be a bad fit.
Step 5: Make a plan
The last major step of buying a second home is deciding how you’ll use the property. Do you want to keep if just for yourself, friends and family to use? Do you want to use it as an investment property and list it on vacation rental sites?
A second home is a great way to earn passive income, and the market for second homes has changed a lot in recent years.
According to Kaley, the rise in people working remotely combined with more people avoiding mass venue vacations means renting a property from sites like VRBO or Vacasa has become popular. This could mean big business for your second home if it’s in a high-demand vacation destination.
It also means that opening your second home as a vacation rental could be a lot more work. Then, it becomes a question of whether the extra income is more than the work you’ll need to put in.
“I often recommend hiring a property manager or property management company,” Frankel said. “While costs and services vary, plan to spend roughly 20-40% of the rental income for property management.”
In the right setting, according to Frankel, that could still leave you with enough income to cover your monthly mortgage payment, set up an emergency fund for the home, and help you build some savings for when you make your second home your primary residence.
Is it time to invest?
When you’re ready to tackle the idea of investing in a second home, don’t take the decision lightly.
“Purchasing a second home can significantly increase the quality of life for you and your family, can be a lucrative investment, can provide rental income, or could put you in a financially stressful situation,” Frankel said. “This is an important financial decision.”