Buying a second home is a goal for many people, but as of 2021 it is a difficult one to accomplish. Many buyers searching for the ideal second home or investment property contributed to the increase in home prices last year. Compared to pre-pandemic levels, demand for second homes increased by 77 percent by the end of 2021.
Low mortgage interest rates, savings from the pandemic shutdown time, and the revolution in hybrid work made it feasible for real people, not just the ultra-wealthy, to live dual lives. However, mortgage rates have increased, so given today’s market conditions, is a second home a good investment? Buying a second home this year may be a good idea, under certain circumstances – let’s examine some of the possibilities.
Second Home as a Vacation Home
People buy second homes for various reasons, such as a vacation spot for the family or an investment home that produces a rental income.
Keep in mind that if you’re buying strictly for a vacation home, the mortgage may be larger than usual due to high home prices, and maintaining a larger second mortgage could become a challenge in the future. Owning a vacation home isn’t a necessity — it’s not the same as purchasing a primary home — so waiting could have some advantages if home prices fall.
When determining if a second home is a good investment, the house’s purchase price is just the beginning. Before moving in, buyers may need or want to renovate. In addition to the necessities like furniture and kitchenware, they’ll be responsible for ongoing costs like property taxes, insurance, utilities, and lawn maintenance.
The worst-case scenarios, such as having to replace the septic tank or pay for a steep increase in homeowners association dues, should also be taken into consideration when calculating the true expenses of owning and maintaining a second home.
Second Home as a Rental Property
If you’re buying a second home with the intention to rent it, now is the time to act. Although you can expect to pay more for the home, rental rates are up on a national level. Having a tenant in the home helps offset the cost of the mortgage.
According to Fannie Mae’s National Housing Survey, over two-thirds of today’s renters said they would purchase a home if their lease ended. Many tenants anticipate rental increases in 2023, and with many tenants unable to purchase homes, rental property is a great long-term investment. Real estate tends to hold its value better than other investments.
Buyers should remember that all the financial burdens of the property rest on their shoulders as a second-home owner — times two. For example, if a primary home’s sewer pipe breaks and then, shortly after, the second home’s HVAC system needs repair, they’ll be hit with two hefty bills.
Tax Breaks on Rental Homes
The IRS deems a property a personal home if it’s rented out for 14 days or less per year, in which case no deductions for expenses are allowed.
Depending on how buyers intend to use the second home, they might be able to write off mortgage interest, real estate taxes, operating costs, depreciation, and repairs. If the homeowner’s own personal use of the property doesn’t exceed 14 days annually or 10% of the number of days the home was rented to others at a reasonable rental price, whichever is greater, owners can maximize the tax deductions.
Is a Second Home a Good Long-Term Investment?
Real estate markets typically move through cycles. An investor who purchases and holds property as a long-term investment can generate high returns on that investment. The Federal Reserve reports that the median sales price of houses sold in the U.S. has increased by more than 64% over the last 10 years. Investors can make a profit by purchasing and maintaining a rental property over the long term.
Is a Second Home a Good Short-Term Investment?
For buyers looking to buy a home, fix it, and resell it for a profit, this is riskier. Supply chain issues can make repair timelines unpredictable, and home values could fall before the buyer can complete all renovations.
Is a Second Home Still a Good Investment Given the Current Market Conditions?
This may not be the ideal time for buyers to purchase a second home as a short-term investment, but a second home remains a profitable long-term investment. The market can be unpredictable, but there are signs of change on the way. For instance, if a buyer waits to buy and the interest rates soar, the second home will no longer be the worthwhile investment it is right now. Here are a few reasons why a second home is still a good investment worth purchasing today, instead of waiting for a change.
Mortgage Rates May Rise
A couple of months into 2022, the Federal Reserve raised interest rates, and mortgage rates began to jump. However, mortgage rates hit a new low on July 28th. Average interest rates for 15-year fixed and 30-year fixed mortgages dropped. Variable rates also tumbled.
According to Freddie Mac, conventional 30-year fixed rate mortgage rates dropped 0.40 percentage points. This drop marked the 8th most significant one-week drop in history. Since the start of the year, mortgage rates had been consistently rising, but this drop gave buyers hope. Interest rates are dynamic and unpredictable, changing on a weekly or even daily basis.
Inflation and federal funds rates have a significant impact on mortgage rates. The Federal Reserve increased rates four times this year, and more increases are expected before the year is over. For new buyers, waiting can mean higher mortgage interest rates and steeper monthly payments. Although home prices can fall in the next few months, rates may also go up, making now the prime time to buy.
Due to the perceived risk involved in lending money for them, second homes have almost always had higher interest rates. The best way to obtain a conventional mortgage with a lower interest rate is to pay off existing debts and save up a larger down payment.
There’s More Inventory
There are fewer buyers competing and a larger selection of inventory to choose from now compared to earlier this year. Buyers have more options and can really choose the best second home as an investment.
The Federal Reserve reports that there are currently more homes for sale in the United States than at any time since December 2021. Additionally, there are fewer active buyers, according to the Mortgage Bankers Association. The national housing inventory will be sold out in 11 weeks if sales continue at the current rate, which is a 62 percent increase from the beginning of the year.
However, more inventory and fewer buyers mean the bidding wars so common in 2021 won’t be an issue. The bidding wars drove home sales above and beyond the list price.
Real Estate as an Inflation Hedge
When home values and rent prices grow more quickly than the annual inflation rate, the rental property also serves as a hedge against inflation. This makes buying a second home a good investment, despite inflation.
The Consumer Price Index (CPI) has changed by 5.3 percent over the past 12 months, according to the U.S. Bureau of Labor Statistics. Although prices are rising, home and rent prices are increasing even more quickly. According to Zillow, the value of a typical middle-priced home in the United States increased by 17.7% over the previous year (through August 31, 2021). Rents have increased by almost as much.
Buyers Have More Negotiating Power
For buyers who are serious about buying and want to maximize their investment, now may be the time to make an offer on a second home. Sellers tend to become anxious when there are more homes for sale and fewer buyers to buy them.
A report by Redfin revealed about 1 in 5 home sellers in the U.S. lowered their asking prices. According to Altos Research, price drops are common in a strong housing market, and this month’s price drops are consistent with previous patterns. The pace of price cuts in July is setting records, benefiting buyers.
The less you pay, the better the second home investment. If the prices of homes increase after you’ve bought your home, you have instant equity.
Is a Second Home a Good Investment Move?
For someone who can maintain the costs of a second home, real estate is a great investment option. However, if you plan to rent out a second home, it’s important not to rely solely on rental income to cover a mortgage payment.
The pandemic and eviction bans left many landlords unable to collect rent for over a year, and other factors can make rental income unsteady. A second home can generate passive income and be a good long-term investment if the value increases. Ensuring you get the best deal and lock-in at a good interest rate is essential. If you purchase a home and values do fall slightly, the ability to hold onto the property until the market moves into a growth cycle is key.
Working with a mortgage broker who specializes in this topic might be a good idea. Check out the broker directory and contact a mortgage expert today, and learn more about how you can access options for a second home.