Looking to diversify your income streams? If you have enough liquid assets from your practice, you might want to consider buying a second home and turning it into a rental property.
However, buying a second home is not always as easy as it may seem. In this article, we are taking a closer look at the steps you have to follow to make a reliable rental property investment.
Evaluate Your Goals and Make a Plan
The first thing you must do is to evaluate your financial and lifestyle goals. Sure, you can afford a second home. What are you going to do with it?
Renting out your second property might pay for your annual vacations, or you can use that second property as your vacation getaway. You may even arrange to rent out your second home when you are not using it, so you can have both a vacation getaway and a passive income stream.
Real Estate Research
For rental properties, you generally have to spend more time researching real estate than when buying your first home. You have to take a number of factors into consideration, including:
- Market trends
- Community utilities
- Neighborhood safety
- Comparable rents
- Zoning laws
- Geographic location
- Climate
- Overall attractiveness
If you are planning to rent out your second home, you have to take into account things that will make it more attractive to potential tenants. For example, if your property is next to a college campus, the property will attract students.
Notice that if you plan to buy property abroad, you will have to visit the location in person and hire a local real estate agent. Residential real estate doesn’t function across countries, so you must find a local real estate agent to help you.
Mortgage Shopping
Unless you have a ton of uninvited money lying around, you will probably want to take out a mortgage to finance the purchase of your second home.
Since you probably did the same for your first home, you are already familiar with the process. However, mortgage lenders are often stricter about second home mortgages unless your credit score is good. Your best bet is to speak with your current mortgage lender.
Your second home mortgage will come with a higher interest rate and a higher down payment. Buying a second home is an investment, and lenders see that as riskier than buying a home to live in.
Even if you have the money for an up-front purchase, you should still consider a mortgage. This will give you more flexibility with your liquid assets and allow you to reinvest your money faster. However, if you can afford a larger down payment, go for it. Since second mortgages are higher than first mortgages, a larger down payment will save you more money in the long run.
Calculate the Extra Costs
Buying a second home is a considerable investment. Even if you have enough money for the purchase without taking out a mortgage, you will still have to cover a number of ongoing expenses as the new owner.
Specifically, you might also have to pay some or all of the following operating expenses:
- Property insurance
- Renovation
- Property management fees
- Ongoing maintenance
- Utility bills
- Homeowners Association fees
Contrary to popular belief, you can’t opt out of homeowners association (HOA) fees. The moment you buy property within the jurisdiction of a homeowners association you are legally required to pay HOA fees.
When running the numbers, aim to keep the operating expenses on your new home between 35% and 80% of your total operating income. For example, if you charge $2,000 a month for rent and your operating expenses are $1,000, you are at 50%. If you pay more than 80%, the investment is really not worth it.
Tax Considerations
Buying a second home gives you certain tax benefits. First, you can deduct insurance, taxes, interest rates, and any other associated expenses against the rental income. You will also be able to deduct any losses from the income of your practice.
Since this is a residential property, you can also deduct property depreciation. Since depreciation cannot be avoided, even if you maintain the house in tip-top shape, you should not ignore any tax deductions for rental property depreciation.
Moreover, if you ever decide to sell this property, you can use the proceeds to buy another rental property and avoid paying capital gains taxes.
Buying a Second Home to Live In
But what if you want to use the second home for yourself? Perhaps you have long commute hours from your first home to your practice and you wish to buy a condo next to your practice.
Without any rental income, a second home can quickly burn a hole in your pocket if you are not careful. In addition to the aforementioned costs, you will also have to shoulder the cost of furnishing and renovating the house to your standards.
Moving to a new house? Check out these tips for a painless experience. As we mentioned before, you can find a compromise between renting out and staying in your second home. Remember that if you rent your property for less than 15 days a year, you won’t have to pay any rental taxes.
Bottom Line on Buying Your Second Home
Whether it’s for personal use or rental income, your second home is a significant investment. If you do your homework and invest smartly, you will see a great return on your investment.
To get started on buying a second home, check out these 10 gorgeous locations. Remember, the more attractive the location, the more affluent renters it will attract!