If one is good, will two be even better?
While personal finance experts generally agree that owning a home provides a boost to just about everybody’s bottom line, for some people, buying a second home may be an overdose of real estate.
Second homes have been immensely popular in recent years. The demographic slice of people aged 45 to 60 is bulging, and this population segment is especially prone to buying vacation homes. But, it’s a person’s finances, not age, that determines the advisability of multiple ownership.
“You have to get your financial `house’ in order first,” says Sherry Hazan-Cohen, a financial planner based in Plano, Tex. “I have a client who wants a beach house in Florida, but he doesn’t have a core plan for educating his children and saving for retirement covered yet. At this point in his life, he is not in the position to purchase a second home from an asset standpoint, but he does have the cash flow to sustain two homes. I strongly discourage him from making a move until he builds a retirement nest egg and gets” college funded for his kids.
Other financial planners echo the general premise underlying Hazan-Cohen’s advice to her client: You not only need the income to swing two mortgages, but you shouldn’t spend it on a second home if it means you’ll neglect goals, like saving for retirement.
Leisa Aiken, a planner with Kabarec Financial Advisors in Palatine, explains that she forecasts how much retirement income a client can reasonably expect given his current level of savings and what future contributions are likely to be if he buys a home. Using conservative estimates for appreciation, Aiken says that if the forecast predicts a shortfall, clients are often advised to curtail home-buying plans.
But given the tantalizing tax benefit (interest is deductible on two mortgages as long as both total less than $1.1 million) and the fact that each mortgage payment builds equity in the house, wouldn’t a second dwelling be a good substitute for a retirement or college savings account?
The short answer offered by experts is this: There should still be assets other than the second home to fund retirement or other key goals.
“You have to understand that the house will be an illiquid asset, not the same as cash in the bank,” says Jim McCabe, a financial planner and president of McCabe Tax & Financial Services, Oak Lawn. “It is harder to get money out of a house than cashing in a savings bond.”
Indeed, even if you plan to sell the house at retirement or take a big equity loan to send the kids through college, the values of homes in vacation areas are notoriously variable, Aiken says. Because Chicago has a large, diverse and relatively stable job market, homes here tend to rise steadily in value, or at worst stay frozen during recessionary periods. Chicago-area residents sometimes expect the same appreciation from their home by a golf course down south or a mountain hideaway, Aiken says, but she’s seen clients struggle with what to do when prices drop in those places.
While all this cautionary advice may sound as irritating as warnings to slather on sun screen before hitting the beach, there are good reasons for individuals with disposable income to invest in a second home.
Because of the tax deductibility of the interest on a second mortgage, “it can be good for high-income people,” says Carol Pankros, a financial planner with CCP Inc., Palatine.
The critical factor is cash flow, says Lisa Williams, a Barrington financial planner and adjunct professor at DePaul University. As long as there’s enough cash left over each month — after funding retirement and other needs — to pay the mortgage and maintenance, a second home can be both a tax break and a good place for a weekend break.
Some buyers plan to offset the cost of a second home by renting it out at least part of the year. Although renting provides owners with the ability to deduct certain expenses, homeowners have to follow complicated tax rules when they file. In some cases, it may be more beneficial simply to keep the residence for personal use, and deduct all the mortgage interest and property taxes, says McCabe.
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