Contributed by: Robert Ingram, CFP®
It’s a dream for many Americans as they envision retirement, having a second home as a vacation getaway, a seasonal escape, or a primary residence someday. Even with the relatively mild winter we’ve just experienced in Michigan, it’s easy to appreciate the idea of living away during the cold months or enjoying a summer home up North. But before you can live the dream, do your due diligence and crunch the numbers.
Retirement income expenses include the daily cost of living and the things you want to enjoy. Making a large purchase, such as buying a second home, will take a significant chunk of your savings. If you’ve underestimated the cost, it will wreak havoc on your retirement income.
So, how realistic is your second home retirement plan? Factor in our suggestions below.
Purchasing costs
If you plan to buy the home using a mortgage, you will of course have a monthly payment. While the continued low interest rates may help with the home’s affordability, this payment does add to the expenses that your retirement income sources will support. Calculate your withdrawal rate (the percentage of savings needed to be withdrawn each year) and determine if it’s sustainable over your retirement years.
Now, if you’re able to purchase the property without a mortgage, yes, you would avoid paying interest and you would have no monthly payment. On the other hand, using a portion of your retirement savings to purchase the home could mean that you have fewer assets reserved for other retirement spending needs. Consider the impact it may have on the sustainability of your retirement income and whether purchasing or financing the property is more advantageous.
Don’t forget about property taxes. They’re ongoing expenses that you must factor into your budget. They vary widely depending on the state and local community. Consider any difference in tax rates; non-homestead property is taxed higher than homestead property.
Additional costs
Unfortunately, we know that the cost of owning a home doesn’t end with the purchase. This is certainly true with a second home as well. Depending on the property type, location, and climate/environment there may be additional costs that you aren’t used to with your current home. It’s vital that your plan supports these costs as well. Some examples include:
Insurance: You’ll pay annual premiums for homeowner’s insurance on two properties. Plus, homes with higher risk (e.g. hurricane prone southern states) often require additional flood or wind damage insurance. In some cases, this nearly doubles the cost of the new policy.
Condo/Association Fees: Buying a condominium or a standalone house in a community with a neighborhood association will likely mean additional monthly fees. Homeowners associations may also impose special assessments during the time you own the property for maintenance projects, community amenities, etc. Understanding the previous history of assessments and the need for future projects can help you better prepare for those potential costs.
Maintenance on two properties: Now you have two homes to maintain. If your second property is far away or you won’t visit often, you may need to hire people locally to provide the maintenance services for you.
Home security: Especially for a home that is unoccupied for long periods of time, you want to protect it from vandalism, trespassing, and burglary. That could mean investing in security systems or working with local service providers to routinely check-in on the property.
Heating and cooling year-round: Unlike cottages or houses up North that you can close down and winterize, vacation homes in warm climates may require you to run the air conditioning when you’re not there. Issues like mold and mildew can be a problem when temperatures and humidity are too high, which is another reason you may need to hire local services to make sure everything is working properly.
Insect/pest control: Your second home may be in a region with insects or other critters that require more regular/aggressive pest control. Add this to your list of monthly or annual maintenance expenses.
What if I plan to rent out my second home?
Renting out your second home could be an excellent way to generate additional income to offset the costs of ownership. However, you could face lifestyle compromises. Here are some considerations:
Local rules on renting: It’s critical to understand any local government ordinances or homeowners association restrictions on using your property as a rental. In some cases, short-term rentals are not allowed or there are limits on the total number of rentals.
Property management: The farther the distance between your rental and primary properties, the greater chance you’ll need to hire a property manager to provide on-site service for your vacation guests or long-term tenants. Property managers can advertise, book renters, and manage financial transactions. The cost to outsource these services is typically between 10-35% of the rental cost.
Additional insurance coverage: Tenants may not be covered by your insurance. Homeowners insurance often covers incidents only when the property is owner-occupied. You may need to add a form of landlord insurance, depending on factors such as the frequency and amount of days you will have the property rented. Review your policy to be sure.
Extra maintenance and repair: You may face repairs and/or need to replace furniture. Studies suggest that the cost to maintain a vacation rental is 1.5-2% of the property value each year.
The decision to buy a second home involves a combination of both lifestyle and financial considerations. Build a sound plan by balancing your priorities. Consult with your financial planner as you work through these important life goals, and if we can be a resource for you, please reach out to us!
Robert Ingram, CFP®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® With more than 15 years of industry experience, he is a trusted source for local media outlets and frequent contributor to The Center’s “Money Centered” blog.