Is Buying A Vacation Home Now Smart?

by Neal Frankle, CFP ®

With real estate prices and interest rates this low, is buying a vacation home a good idea? More and more people think so according to the National Association of Realtors*. They recently reported a 7% jump in vacation home purchases. Foreclosures and short-sale properties only contribute to this surge in vacation home purchases.

But is it a good idea? Is it the smart way to make an investment in rental property? I believe the answer is “no” for most people if they look at this from a financial perspective. Let me explain why.

1. Not an Investment for Most People

Owning a vacation home is typically a terrible investment. This is not to say that you shouldn’t buy a vacation home. But from a financial perspective, vacation homes rarely work. Let’s look at an example.

Say you buy a wonderful place in the mountains for $150,000 and go up to stay there for one week every 2 months. That means over an entire 12 month period, you are going to spend 6 weeks up in the country. Consider what it really costs you to own that property each year (mortgage, taxes, repair and maintenance). And don’t forget to add in the investment return you could have earned on the money you used for a down payment had you invested it instead of buying the vacation home.

Even though interest rates are very low right now, it could still run you $7,000 to $8,000 a year to own that place – at least. Now compare that to what it would cost you to rent a home for 6 weeks. Unless the cost of renting is extremely high, the odds are that you can rent much cheaper.

Of course there are financial offsets that reduce the cost of owning a vacation property. For example, if you rent out the property and/or get tax deductions as a result of the purchase, those items make it less expensive to own the property.

In short, your first step is to figure out ALL the net costs associated with owning the vacation home and then compare that to renting the property for the actual time you’ll be spending there. In most cases you’ll see discover that you are better off renting rather than buying that vacation home.

2. Little Appreciation

If you buy real estate now you might indeed be able to capture some sweet price appreciation. But please understand that vacation properties usually don’t appreciate as much as other residential real estate.

According to National Association of Realtors, investment home prices rose 6.1% in 2011. But the price for vacation homes dropped 19%. Why? Because there is much less demand for vacation property than for residential property.

If the vacation spot of your dreams has tight inventory, prices might rise faster than average vacation property. But the bottom line is that there are far fewer people with the scratch to own second homes. As a result, there will be less demand and that’s going to keep your vacation property appreciation low.

3. Interest rates.buying a vacation home

It’s true that interest rates are ridiculously low right now. Today you can get a 15 year mortgage at about 2.65% which is stupefying. And rates could stay low for several years. Why? Because the Fed has made it very clear they intend to keep rates low until unemployment drops below 6.5%. And they don’t expect that to happen until the end of 2015 at the earliest.

But low interest rates don’t tell you the entire mortgage story. First, even though the payments are low, it’s still going to be tough to qualify for a loan. If you are serious about buying a vacation home, you will probably have to cough up 30% to 40% for a down payment. Banks require larger down payments on vacation properties because there are far more defaults on those types of loans. And by the way…you might want to ask yourself why there are more defaults on vacation properties as compared to other real estate. The answer is that most people learn the hard way what I’m telling you right now – it’s just not worth it to own a vacation home.

And by the way, if interest rates are low, doesn’t that signal a continuation of our soft economy? People are cutting back on their spending and are more focused on getting out of debt, building their saving and getting serious about investing. That tells me there will be even fewer buyers for your vacation property should you decide to sell some day.

A vacation property is a luxury. If you can afford it, go for it. Who am I to suggest otherwise? But if you can’t afford to keep tens of thousands or hundreds of thousands of dollars locked up in an investment that won’t perform, you are better off renting a vacation property when you want one rather than buying one.

Do you own a vacation home? Has it worked out financially? What haven’t I taken into account?

 

http://www.realtor.org/

 

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