Investing in a vacation home can be an excellent opportunity for homebuyers to generate passive income while enjoying a peaceful retreat.
However, buying a vacation home is more complex than picking a location and signing a contract. From financing options to location, there is a lot to consider.
Buying a vacation home vs. buying a second home
A second home is typically a property bought for personal use. It could be a city apartment or beach house, which the owner might use throughout the year.
However, a vacation home like an Airbnb investment property purchased for short-term renters, such as vacationers and tourists. The location of a vacation home is usually in a popular vacation destination, close to tourist attractions and activities.
As an investor, owning a vacation home means you could have a steady flow of rental income while occasionally using the property for personal vacations. While it might require more maintenance and management, there is potential for a return on your investment.
Real estate and lender requirements
Lenders may have stricter requirements when financing a vacation home than a primary residence.
In general, for a property to be considered a second home and eligible for a second home loan, the borrower must intend to occupy the property for some portion of the year, usually at least 14 days or 10% of the time that the property is rented out, whichever is greater.
To qualify as a vacation home, the borrower must intend to rent the property for at least some portion of the year, typically at least 14 days. The borrower must also plan to use the property for personal use for a limited time, usually at most 14 days per year or 10% of the time the property is rented out, whichever is greater.
Here are some additional general guidelines to consider when financing a vacation home:
- Borrower: Can stay within the maximum debt-to-income ratio and must meet the minimums for the down payment and credit score.
- Debt-to-income ratio: Lenders typically prefer a debt-to-income ratio of 43% or lower. This means the borrower’s debt, including mortgage payments, should be at most 43% of their income.
- Credit score: While all lenders set their own credit score requirements, higher credit scores may qualify for better interest rates and loan terms.
- Cash reserves: Because a vacation or second home can be riskier for lenders, they may require the borrower to have more cash reserves than they would for a primary residence. This means the borrower must have a certain amount of savings after the down payment and closing costs are paid, often two to six months’ worth of expenses and mortgage payments.
It’s important to note that while these are general guidelines, each lender may have specific requirements. It’s always best to speak with a lender who can guide you through the lending requirements specific to your situation.
Why mortgage rates differ for vacation homes
Mortgage rates are typically higher for vacation homes (as opposed to your primary residence) due to the risk of owning a second property.
Since you already have a primary home to live in, a lender may deem a borrower a higher risk and more likely to default on a vacation home loan if things don’t go according to plan. If you default, the bank will be out of money, but you will still have a place to reside.
However, you may qualify for certain tax deductions with a vacation home. For this to happen, it must be a rental property and not your primary residence. Suppose you generate income from your vacation rental property for more than two weeks a year. In that case, you can receive tax breaks on your upkeep, such as property management, maintenance and repairs, landscaping, supplies, insurance, property taxes, and mortgage interest.
How to invest in a vacation rental
Investing in the right vacation rental means performing a lot of research, especially regarding location. Location is a driving force for profitability.
As you research travel locations, it is also a good time to contact a lender who deals with vacation rental lending. It also helps to get pre-approved. Getting a pre-approval puts you ahead of the game as you can move quickly on a good deal while also letting sellers know you’re trustworthy and have the resources to close the deal.
Benefits of Investing in a Vacation Home
- Stable income: Short-term rentals can provide a steady income stream, especially if the property is in a popular vacation retreat.
- Tax benefits: Investors can take advantage of several tax deductions, including home mortgage interest, property taxes, and depreciation.
- Diversification: Investing in a vacation home can help diversify a real estate investor’s portfolio, reducing risk and increasing potential returns.
- Personal use: Vacation homes can offer a private retreat for investors, family, and friends.
- Potential for appreciation: A property in a desirable location can see home values rise over time, allowing the investor to sell for a profit in the future.
8 steps to follow when purchasing a vacation rental
Buying a vacation home is a lot different than purchasing your primary residence.
1. Work with a real estate agent: Let your realtor know if you want to use your vacation home as a short-term rental property. Doing so will help them weed out any properties that are not appropriate for short-term rentals, such as a community that has homeowner’s association (HOA) fees or areas with restrictions against vacation rentals. Keeping your real estate agent in the loop will ensure you find what you are looking for and prevent you from being stuck with a property you can’t use as intended.
2. Find the best location you can afford. Consider high-traffic areas where people vacation frequently. Review the area comps with your real estate agent to ensure your property measures up. For an easier sale down the road, purchase your vacation rental in a location where value is increasing.
3. Visit before you buy. Familiarize yourself with the area in which you are planning to purchase a vacation property. Vacationing in that area will show you where the best restaurants, venues, and special attractions are. Getting to know the location well makes your decision easier when it comes to buying a vacation home. Additionally, this information will be helpful when marketing the property for rent.
4. Decide whether you will hire a property manager. If your vacation home is far from your primary residence, consider hiring a property manager. A professional manager will save you time, resources, and energy as they will handle the cleaning, maintaining the property, screening applicants, and more.
5. Create a budget and stick to it. Come up with a budget before looking at potential vacation rental properties and avoid going over that amount. When creating your budget, factor in any costs besides the mortgage, including operating expenses, supplies, and flood or hurricane insurance, if applicable.
6. Get a mortgage pre-approval. Acquiring a vacation home will be easier if you are pre-approved for financing. To prepare, check your credit score first and save for a down payment. For the pre-approval process, the lender may ask for the following:
- Proof of income
- Credit check
- Proof of assets
- Verification of employment
- Social Security number, driver’s license, and proof of current address
7. Make an offer. Once you have chosen your location and property, you must put in an offer and list the terms and conditions you’re willing to accept for the price offered. You will then need to set a closing date and submit an earnest money payment held in escrow until the close of the sale.
8. Close on the home. If your offer is accepted, closing on a vacation home is not much different than your primary residence. You’ll need to have the home inspected, review the seller’s disclosures, and work with your mortgage provider to get through underwriting.
Should you invest in a vacation home?
Investing in a vacation home can be an attractive opportunity for real estate investors willing to put in the time and effort to manage the property effectively. While there are risks and challenges associated with owning a vacation home, there is also the potential for long-term passive income, tax advantages, and personal use.
As with any investment, it’s essential to do your due diligence, research the market, and work with a reputable lender or real estate professional who can help guide you.
Looking to invest in the vacation rental market but don’t want to deal with the hassle of managing a property yourself? With Arrived, you can invest in vacation rentals in pre-vetted markets. Arrived takes care of the booking, guest management, and maintenance, so you can skip the hassle.
The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. The views reflected in the commentary are subject to change at any time without notice. View Arrived’s disclaimers.