March 30 2004
Not long ago, Frank Kwok moved from a 900-square-foot townhouse on the North Shore of Oahu "because we wanted our own home with a yard and everything." So he bought a 2,500-square-foot home in what he calls the "bustling suburb" of Kapolei, not far from Honolulu. He kept the tiny townhouse in the beach town of Haleiwa. It's now his family's second home: "We go back there whenever we don't want to be bothered by neighbors."
Kwok did it backward -- turning the first home into the getaway home -- but he did something that many Americans do or dream of doing: He bought a second home.
Buying a second home isn't much different from buying a primary residence. If you don't rent it out regularly, so it's not considered an investment property, you can get the same mortgage rate that you would get on your primary house. Depending on circumstances, you might be able to deduct the mortgage interest from income taxes.
When you shop for a second or vacation home, you have two friends: time and your primary home's equity.
"If they look for a second home, people need to be patient," Kwok says. "Don't rush into it. They already have a place to live. Weigh the pros and cons of each place."
Bob Walters, vice president of Quicken Mortgage, delivers the same advice. "Don't make any rash decisions," he says. "There's no reason you have to buy it right now. If you find a place and love the place, stew on it a couple of months. It'll still be there."
The cooling-off period
During your self-imposed cooling-off period, think long and hard about how often you will visit and how much time you will spend. Are you the type of person who buys a 12-month health-club membership, then stops going after a few weeks? If you are, what makes you think you will treat the vacation home differently?
Even if you feel positive that you will spend sufficient time at the second home, you must decide whether it's worth the money. "I think second homes, more so than primary residences, have to be treated as an investment," Walters says. And he's not talking about investment properties that are rented out.
"You have to view it with a cold and calculated eye," Walters says.
How much time will you spend there? What will be the price appreciation -- realistically? How much will you have to pay every year for landscaping, association dues, garbage collection and taxes?
"They gotta do the math," Walters says. "Calculate how much it will cost them annually. Calculate their financial return."
And don't try to time the purchase to get a better price. That tactic rarely works, says Diane Saatchi, a real estate agent who sells homes in the Hamptons on Long Island. Buyers sometimes think they'll get a better deal on a home in the Hamptons in the winter, or on a home in Florida in the summer. But sellers are savvy, and home values don't fluctuate by season.
"What I tell people all the time is that the best time to buy a house is when you want a house," Saatchi says.
Ease your doubts
She also recommends that you request photos of the property taken during different seasons. If you go house-hunting in the Hamptons during the winter, neighboring houses might seem too close because of the lack of leaves on the trees. A picture taken during the summer, when you'll spend most of your time there, can allay your fears of being crowded by your neighbors.
Saatchi adds that you should ask around for a trustworthy real estate agent to show you around -- someone who will tell you about the all-night parties that are often held on a particular stretch of beach, or about the next-door neighbors who plan to build a tennis court just a few feet from your bedroom.
Finally, she says, make sure you can get the insurance you need, particularly if you want to buy a home near the beach. "That's a good thing to know -- the availability and cost of insurance -- before you pay for legal fees and inspections," she says.
Financing the deal
OK, you have done the math, looked at year-round photos of the property, and thought it over for a while. You have decided that, yes, you want to buy that cabin in the mountains or that condo on the beach. If you don't have the cash to pay for it outright, the next step is to find a mortgage. The lender or broker who handled the mortgage on your primary home is an excellent place to start if you were satisfied with the service you got.
But you might have to shop around. Different lenders have different standards when it comes to mortgages on vacation homes, as Bill Andrus of Denver has discovered. He owns two condos in major ski areas, and rents them out as much as possible.
"Some lenders won't touch second or third homes, others solicit them, and yet others offer normal rates without the investor penalties, as long as we occupy them sometimes," Andrus says.
Walters says that the loan standards for primary and secondary homes are virtually identical, especially for conventional loans -- in other words, loans for amounts under the jumbo limit (in 2003, that's $322,700). Rates are about the same, unless the lender considers the house an investment property. In that case, expect to pay an interest rate about 1.5 to 2 percentage points higher. As Andrus points out, some lenders might grant a lot of leeway when deciding whether a vacation home is an investment property.
When it's time to make a down payment on your second home, you can use the equity in your primary home. You can either extract the equity by doing a "cash-out" refinance, or by getting a home equity loan or an equity line of credit. You can use that equity to make all or some of the down payment on the second home.
There are complex tax implications to borrowing to buy a second home. Generally speaking, the interest is deductible from federal income taxes. But if you borrow from the equity on your first home to make a down payment on the second home, you can write off the interest on only the first $100,000 of equity debt.
If you rent out the second home, you have to spend a certain amount of time in the home every year to be able to deduct the interest. Your best bet is to read IRS Publication 936, Home Mortgage Interest Deduction and Publication 527, Residential Rental Property. Once those have confused you, consult an accountant.