The decision to purchase a second property, whether as a vacation retreat or an investment, is significant. There are pros and cons to each – especially when it comes to potential income, mortgages and other expenses, tax benefits, responsibilities, liabilities, and appreciation potential. Let’s explore the options.

Vacation Home

A vacation home offers a retreat for relaxation or family visits, but it also comes with responsibilities. Here are the key considerations.

Potential Rental Income

When you and your family are not spending time at your second property, you may rent it out to offset your ownership costs and generate some extra income. Short-term vacation rentals can be quite profitable if they are in a popular spot. However, you might face some restrictions based on the type of mortgage you get, and you will be adding some time-consuming responsibilities, which we will discuss a little later.

Appreciation Potential

Like other real estate, your vacation home can increase in value over time, offering a positive return on investment if you decide to sell it in the future. This will, of course, depend on the popularity of your home’s location and the favorability of market conditions.

Tax Benefits

As with your primary home, mortgage interest and property taxes are tax-deductible for your vacation home. You may also qualify for other deductions, like depreciation and travel expenses associated with upkeep. You will need to speak with a tax professional to ensure you understand all the tax rules, in addition to benefits, associated with owning a second home.

Equity Building

Much like with your first home, you are building equity as you pay off the mortgage on your vacation home. You can potentially access this money later through refinancing or home equity loans, offering you some extra financial flexibility.

High Upfront Costs

A vacation home can be expensive, especially in a resort area. You will need to budget for a down payment, closing costs, mortgage payments, furnishings, and potential renovations before you even move in. Keep in mind that lenders see vacation homes as riskier investments because they may sit vacant for parts of each year and sustain damage from occasional use. Also, because borrowers are more likely to default on secondary versus primary property payments, your mortgage rate and down payment may be higher. Finally, because buying a second home is considered a luxury, you likely will not qualify for government-backed home loans.

Ongoing Expenses

Property taxes, insurance, maintenance, utilities, and homeowners association fees (if applicable) are recurring costs that you’ll need to factor into your budget. Insurance rates for a second residence are typically higher than for a primary home due to increased risks associated with being unoccupied for portions of the year. You’ll be paying travel costs for planned trips to and from your vacation home, but you may also be making unplanned trips to handle regular maintenance or any problems that occur at the property, if you are not paying someone local to handle these issues.

Rental Responsibilities

Managing a vacation rental can be quite time-consuming and demanding. If you plan to rent out your second home, you will need to manage bookings, cleaning, repairs, and guest communication, unless you hire someone to handle those responsibilities. Rental value often fluctuates depending on your property’s location, the season, and the state of the economy – and periods of vacancy can impact your profits.

Investment Property

An investment property is a property you buy to generate income through rentals or, in some cases, when you flip and sell. The most common type of investment property is one used for residential rentals, so that’s what we’ll focus on here. There are pros and cons to purchasing an investment property, and acquiring and managing these properties can be more complex than buying a second home for personal use with minimal rentals.

Passive Income

Investment properties don’t need to be occupied by the borrower for a portion of the year, which means they can be rented on a short-term, long-term, or annual basis. That could translate to a significant amount of potential rental income. Keep in mind that real estate values are tied to market fluctuations, so you may see a decline in value during economic downturns. The stability of your rental income may also fluctuate depending on local market conditions, vacancy rates, and seasonal demand.

Increased Financial Advantages

Owners of investment properties can claim deductions for mortgage interest, property taxes, insurance, maintenance, utilities, and losses sustained due to damage, as well as a percentage of the property’s value each year due to depreciation. Real estate can be a valuable addition to a diversified investment portfolio, as it operates independently of the stock market, so having property as part of your portfolio can reduce overall volatility. Like a vacation home, your investment property can increase in value over time, offering a positive return on investment if you decide to sell it.

Leverage

When you make a real estate investment, you can put down a portion of the property’s price as a down payment and borrow the remaining amount as a mortgage. If you make a 20% down payment and borrow the remaining 80%, any appreciation of the property value is amplified by a factor of five, which could lead to a significant return on investment.

Liability Concerns

Adequate insurance coverage is a must to protect yourself from liability risks. If someone is injured on your property, you could be held responsible. For investment property, you’ll need second home insurance that protects against damage from things like storms, fire, and vandalism, as well as rental property insurance to protect against tenant-related property damage, liability claims, and loss of rental income.

Active Management

Investment properties require management, including making sure the property is regularly maintained, ensuring legal compliance, and handling tenant screenings. If you don’t have the personal time to dedicate to these tasks, you can hire a property manager, which will add to your expenses. You will need to collect rent, handle maintenance requests, and deal with tenant disputes. If a tenant or a guest of a tenant damages the property, or your tenant doesn’t pay rent, you could be dealing with unexpected costs and complications.

The Choice Is Yours

If you’re ready to buy a second property, the choice between a vacation home and an investment property comes down to your personal or financial goals and how much time you’re willing to commit to the property.

 

Want to learn more about the unique considerations involved in purchasing a vacation home or an investment property? Reach out today.

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