Should You Be Selling Your Vacation Home Right Now?
: John Wasik
Aug. 16 (Bloomberg) -- Does owning a vacation home make sense, or does it make your financial future less than summery?
In what may be an overheated residential market, it's a good time to reconsider how second -- and even primary -- homes contribute to your financial goals, and to sell any real estate that creates oppressive debt.
You'll have to go against conventional wisdom to decide whether to sell in this market. The mantra of upward mobility dictates that you buy as much house as you can afford, then buy that second residence. Often a move in the opposite direction may ensure financial security.
Jo Ann and John Karnatz of Fox Lake, Illinois, sold their 3,000-square-foot single-family home to move into a 1,800-square- foot townhouse, then sold their vacation home in northern Wisconsin. After freeing up $100,000 in equity from the two home sales, they were able not only to pay off some debts, they gained some seed money to buy a home health-care franchise -- something they've wanted to do for years.
``We are saving 70 percent in living costs in our town home,'' Jo Ann Karnatz says. ``We downsized to improve our cash flow and to put something toward retirement.''
The Market
Second homes may make a smooth retirement more difficult if they short-circuit your long-term financial goals.
Yet it's hard to argue why a vacation home might not be a good idea as the 77 million-strong baby boomer generation propels first- and second-home sales and prices to new heights. As the post-World War II generation gets older and more prosperous, it's buying country homes en masse.
In 2003, a record 445,000 vacation homes sold, according to the National Association of Realtors, a real-estate trade association. That was up 24 percent from the previous record high in 2001.
The association also says vacation-home prices will probably increase at a pace double that for first homes, which are projected to rise about 6.7 percent this year. Overall, median existing-home prices were up 9.1 percent in the second quarter over the same period in 2003, with 49 markets showing gains of at least 10 percent, the association reported last week.
Is it economic madness to want to sell -- or not buy -- a second home in a rising market? It depends on your situation.
Rainy Day Fund
You may consider bolstering your cash reserves instead of buying a piece of illiquid property in a pricey market.
It's important to consider your job security and the state of the economy. If you're in a volatile industry or subject to downsizing or outsourcing, taking on more mortgage debt is hazardous.
Unless you have a secure civil-service position, most financial planners recommend tucking away at least six months of cash for emergencies. If you work for yourself, you also need to have long-term disability insurance to cover your income if you can't work and are the sole breadwinner.
Too many households have insufficient rainy-day money, though. According to a recent study by the Levy Economics Institute, almost 42 percent of all U.S. households were in ``asset poverty'' -- that is, they didn't have enough cash to cover expenses for at least three months.
Cash Flow
Whether you're considering a new home, second home or investment property, cash flow is the linchpin of making the right decision.
You not only have to focus on whether you will be spending 30 percent or less of your annual income on home costs -- the suggested guideline for most house purchases -- you also have to consider your retirement and college funding plans, if applicable.
Michael Dubis, a fee-only certified financial planner in Madison, Wisconsin, suggests taking a comprehensive look at how your cash can work for you now and in the future. Start with your retirement planning goals.
``Many folks I've seen under the age of 35 haven't put anything away yet. At that point, to not be putting away 20 percent to 30 percent of your gross income at age 35 and older, you won't get close to financial security when you retire,'' Dubis says.
True Costs
If you're considering another property, you need to compare the total cost of ownership with renting. Too many homeowners assume that a home is a pure investment and neglect to tally all expenses of ownership that diminish their rate of return.
To see if a property makes sense, do an analysis that includes: property taxes; maintenance, insurance and utility costs of at least 2 percent (of the home's sale price) a year; association fees (for condominiums and townhouses); selling costs (6 percent sales commission and other closing costs); and mortgage payments (principal and interest).
Now compare the full cost of ownership with a comparable rental property. For example, Dubis examined a $750,000 property financed at 6.5 percent over 30 years, with a property-tax rate of 1.5 percent and a down payment of $150,000, appreciating at 3 percent annually with a 3 percent inflation rate.
Under Dubis's assumptions, this property doesn't have a positive net value until the fifth year of ownership, even though the home's market price will rise to almost $870,000. The rental option is comparatively better in the early years. This is also a useful exercise for primary homes if you know you will only be living in an area for less than five years.
Another View
Also consider the liquidity and price level where you are buying. Certain locations may be overbuilt and overpriced, and you may be buying in at the peak of the market. So your property may be harder to sell in the future.
Here's another simple guideline to avoid trouble: Your mortgage should be no more than 2.5 times your gross income. So if you make $100,000, then a $250,000 loan is a good starting point, provided you also have enough monthly cash to cover taxes, insurance, maintenance and other expenses.
``If you want any type of financial security, you have to take this equation seriously,'' Dubis adds.
While it's often gratifying to see both your primary and secondary home appreciate in value with no effort on your part, home-price increases aren't guaranteed. Remember that Southern California, Boston and Houston have all experienced housing declines in the past quarter century.
That's why it's important to see whether your home is truly building your wealth. Even if your home is where your heart is, doing the math now will avoid financial angina in the future.
quote.bloomberg.com
To contact the writer of this column:
John F. Wasik in Chicago at jwasik@bloomberg.net.
Last Updated: August 16, 2004 00:12 EDT |
