Who hasn’t dreamed of owning a vacation home near the beach or nestled in the mountains? Today, with rental marketing sites such as Airbnb and Vrbo offering the possibility of rental income to help pay the mortgage, owning a second home in a resort town isn’t an option reserved only for the wealthy. 

Around 29% of [non-investment] vacation home buyers rented or tried to rent their property, according to the 2017 NAR Investment & Vacation Home Buyer’s Survey by the National Association of Realtors.

Another 42% of vacation home buyers plan to use the property for vacations or as a family retreat, and 18% want to convert a vacation home into their primary residence later in retirement. 

Whether you plan to put your vacation home’s rental income toward its monthly mortgage payments or use the home as a family retreat, there is more to consider with a vacation home than how often you’ll get to soak in that hot tub on the deck. 

When you own a vacation home, unexpected expenses and responsibilities can invade your idyllic paradise if you don’t do your research before purchasing.

Vacation home costs add up

“The owner may want to consider owning in the form of a limited liability company (LLC) to shield them from liability.”
–Michael Romer, Romer Debbas LLP

Before buying a vacation home, you should understand both the acquisition and carrying costs of the property, says Michael Romer, a real estate attorney and managing partner of Romer Debbas LLP in New York City.

Carrying costs can include utilities, homeowners or condominium association fees and property taxes.

If you plan to rent out the home, you may also have to pay for property management, cleaning services, additional liability insurance and taxes on rental income. 

“Have a plan for how the property will be used,” says Romer. If you will rent the home out when vacant, have a basic idea of projected rent income and create a basic rental business plan. Know how often you plan to rent out the vacation home and how you will market it. 

“The owner may want to consider owning in the form of a limited liability company (LLC) to shield them from liability,” says Romer.

Make sure you talk with a local real estate agent familiar with the vacation home market to help you buy at the right time. “Resort areas often experience dramatic swings in property values, and when people have less disposable income, a vacation home is often first on the list to sell,” says Julie Upton, a San Francisco Bay Area realtor with Compass, a real estate brokerage firm. 

Upton recommends using an agent from the resort town who knows where the area is in the real estate cycle to avoid buying at the peak, unless you plan on keeping the property for a long time.

1. Can I afford the total cost of a vacation home?

In addition to shelling out funds to furnish the home and paying carrying costs such as insurance, taxes, utilities and HOA fees, you’ll have to hire a property management company and cleaning service if you plan to rent the property. 

“If a client plans on renting, we make an estimate of what they feel they can receive from rent and factor in maintenance, insurance and taxes,” says Jeffrey Corliss, CFP, managing director and partner at RDM Financial Group in Westport, Connecticut. “Rental income is taxable, so you may get $1,000 but Uncle Sam takes a portion of that.”

Even if you don’t intend to rent the home out, the cash flow to feed and entertain visiting family members can add up significantly, says Corliss.

2. Am I counting on rental income to pay for the house?

Relying on rental income to pay part of the mortgage can be a risky endeavor. “Be conservative when projecting what the rental income will be,” says Romer. “Factor in that the property may go unrented for a while.”

Romer recommends meeting with your accountant to go over taxes associated with rental income and potential capital gains taxes should you or an heir decide to sell. 

Keep in mind that many popular areas are saturated with competing vacation rentals. Search vacation rentals in the area on Airbnb, Vrbo and other rental sites to compare nearby properties and to gauge rental income potential.

3. Do I understand local laws on vacation rentals?

Many cities and towns have ordinances with requirements or restrictions on vacation rentals. For example, Carlsbad, California, bans vacation rentals except for those in a designated “coastal zone.”

In Florida, vacation rentals must be licensed by the state. In Miami-Dade County, the owner or responsible party must reside in the rental property for more than six months out of the year if they want to rent it out.

Visit the city website where you’re looking for a vacation home to find local vacation rental ordinances.

4. How will buying a second home affect my retirement goals?

Before buying a vacation home, honestly assess how the purchase may affect other retirement goals, says Corliss. For example, will you still be able to meet your retirement date goal, pay for your grandkids’ education or keep enough in savings to pay for possible long-term care costs as you age? 

5. Do I want to go back to the same place again and again?

Just because you loved that quirky town in Sonoma wine country or experienced serenity meditating on a Sedona vortex doesn’t mean you’ll want to spend every vacation at the same destination. When you own a vacation home, you may have to limit vacations elsewhere to get the most out of your purchase, or because the home’s additional expenses limit your travel budget.

Once you’ve considered these factors, you may find you’re better off financially if you rent someone else’s vacation home for a few months a year instead of buying your own. That way, you’re free of maintenance and carrying costs, along with the mortgage loan. 

Or, you may decide that a vacation home is just what you need. Before making your purchase, however, Corliss recommends meeting with your financial advisor to make sure you understand all financial implications of owning and/or renting out a vacation home. 

“Having a financial plan based on your current situation is the best way to avoid a major financial issue,” says Corliss.