As spring approaches, many families consider the possibility of purchasing a vacation home at the beach, mountains or favorite get away location. There are many reasons people consider owning a second home. These can vary from a haven to enjoy time with friends and fellowship to beginning to use a home that may be a retirement destination. Regardless of your motivation, there are several financial issues to consider and evaluate so that your decision is well thought out and you can use the home for years to come.
- Consider the type and structure of your financingAs we enter a period of rising interest rates, it is more critical than ever to determine the best way to finance the property. If you feel that you may be in the property for a set number of years while children or grandchildren are young, you may be better off with an adjustable rate, interest only loan. This loan would lock your rate for a period of time and allow you flexibility in terms of paying principal, interest or both. The challenge could be if at the end of the term of the loan, you decide you still want to be in the property, you may be in a period of higher interest rates. If you are confident that the home will be a place your family will want to own for many years, you should consider a fixed rate, traditional mortgage. While this may mean a higher monthly payment of interest and principal, the rate will be fixed and not subject to fluctuation. Whatever path you choose in establishing financing, while you are going through the mortgage process, it is a good idea to establish a home equity line of credit. This provides a good tax efficient safety net in the event you need to access liquidity or do some renovations on the property. From a tax deductibility perspective, the interest on the mortgages on your primary and vacation homes are deductible up to $1,000,000 and a home equity line is deductible up to $100k. You should also consider what the acquisition of additional debt means to reviewing your life insurance program.
- In your budgeting, ideally keep your debt service to less than 35% of your take home payWhile there are many non-financial benefits of owning a second home, it is hard to make an argument that they are a good investment. By keeping your net debt service outflow to around 35% of your take home pay, you still have ample cash flow to save, invest, make home improvements, maintain your standard of living as well as give to loved ones and charity. Understand as well that a second home brings with it a second set of bills for gas, water, electric, landscaping, property taxes, maintenance and upkeep. Added all up on an annual basis, that could represent 5 to 10% of the value of the home itself.
- Protect the home from litigious activity As you are considering home owners insurance, don’t forget to add a personal umbrella to cover your vacation home as well. The personal umbrella is a policy that provides a layer of protection between you and your financial assets in the event you are sued. For instance, a contractor comes to the house for a project, says she is insured but is not, falls down your steps and breaks an ankle. If she brings a law suit against you, the umbrella puts a layer over your liquid assets. As a rule of thumb, it is recommended to have an umbrella equal to your liquid asset base. If you plan on renting the home even for a few weeks a year, consider owning the home in a LLC. The LLC provides an even stronger layer of protection than an umbrella because the LLC is the actual owner of the home. In the event of lawsuit, the LLC owns the property, not you, so your assets are protected.
A vacation home can be a great enhancement to your quality of life and provide a magnet for friends and family to gather. We feel it is important to consider these prudent issues before any definite decisions are made. Please feel welcome to call or email with any questions.
Gregory C. Sarian
CPWA®|CIMA®|CFP®|ChFC®|CEPA®
Managing Director & Partner
The Sarian Group at HighTower
HighTower does not provide tax or legal advice. Investors are urged to consult their tax or legal advisor prior to making decisions.
Greg Sarian is registered with HighTower Securities, LLC, member FINRA, MSRB and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.
This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.
All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. Greg Sarian and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.
This document was created for informational purposes only; the opinions expressed are solely those of Greg Sarian and do not represent those of HighTower Advisors, LLC, or any of its affiliates.