The Keys to Paradise
With a methodical approach to saving and a strategy for cutting costs, you can go from zero to second-home hero in just 5 years. Here's your 15-step action plan for making it happen. You love your house. But let's face it, the passion has waned.
Sure, the old ball-and-chain is fully functional: It's close to work, in a good school district, and big enough to contain all your stuff. It's your physical shelter and a great tax deduction. But after a tough grind at the office or during lunch, when your mind wanders, you might find yourself fantasizing about something sexier, more exotic. Admit it: You're mentally cheating on your house. Embrace it: Buying a second home is the only form of betrayal that your lovely lady will ever endorse.
So let's cut to the chase: Can you make this happen? Yes, you can. In fact, with a little discipline, you can get there in 5 years. By earning just 4.5 percent on your money, you'd be able to secure a 10 percent down payment on a $500,000 dream home by socking away just $25 a day.
That's the price of 7 gallons of gas and a cafe latte.
Why the 5-year target?
Economic reality, that's why. You've got a retirement to prepare for, and you probably have kids to educate. You also need to be ready for any unforeseen financial challenges that crop up. Just as rising interest rates are helping cool home-price appreciation and discourage real-estate speculators, rising rates will boost the return on your savings. A 5-year runway enables you to leverage compound interest to get to your down payment without disrupting your other financial goals. Five years is also plenty of time to explore your second-home alternatives, find ways to trim costs, and turn your real-estate fantasy into reality.
If Lenin could muscle the entire Soviet economy in 5-year time spans, you can marshal your resources and achieve your second-home dream. Here's how to make it happen.
Lay the Groundwork
When you miss a few sessions at the gym, you have to work twice as hard the next time to make any progress. Your motivation might even slip. The same goes for your goal of owning a second home: Relentless dedication is everything. Your strategy begins with a realistic savings plan.
Create your down-payment strategy
To stay focused, open a separate account and call it your "sunny day fund." To enforce discipline, set up a monthly electronic transfer so you can move funds into the account without ever having to think about it. Then drop extra money into the account whenever you can. That's what Ethan and Renee Chandler did.
The Richmond, Virginia, couple started putting money away before they had settled on a location -- or even agreed that they would buy a vacation home. "Over six years, we hoarded any stock options, any bonuses, any pay increases," says Renee, 35. "We reduced all our debt, didn't do big upgrades to the house, and didn't sell those stock options to splurge on something unnecessary." When the time came, the Chandlers easily had enough cash for a 10 percent down payment on a $300,000 two-story gem on the bay in Vieques, Puerto Rico.
Invest your sunny-day fund wisely
There's another good reason to keep your down-payment money separate from funds you sock away for other goals: Your investing strategy should be radically different. As a rule of thumb, you should avoid stocks if you need the money in fewer than 7 years, says financial advisor Shashin Shah, president of SGS Wealth Management, in Dallas. The reason is simple: The market might be slumping just when you need to withdraw funds, forcing you to lock in a loss. Thankfully, rising interest rates mean boring is once again beautiful: A nearly risk-free, high-yield money market account, such as the one offered by online bank HSBCdirect, pays that magic 4.5 percent annually.
One-year certificates of deposit, which are slightly less liquid, are also market beaters: ING Direct, another online bank, offers 5.25 percent with no minimum deposit. If you're in a high tax bracket, adds Harold Evensky, chairman of wealth-management firm Evensky & Katz, in Coral Gables, Florida, you can bump up your returns by moving a portion of your money into a low-cost mutual fund that invests in tax-free, short-term municipal bonds.
Factor inflation into your savings equation
A big variable that affects your down-payment goal is the rate of appreciation in markets where you want to buy. Get a feel for what you're up against by doing some price sleuthing on specialty second-home Web sites like EscapeHomes.com or generalist real-estate sites like HomeGain.com. You can also buy intelligence from an outfit like the Local Market Monitor, a consultancy in Wellesley, Massachusetts, that calculates average prices for more than 100 markets.
With an estimate in hand, back into your savings goal by projecting what a home that you like in today's dollars will cost you down the road. Last year, for example, the median-priced vacation home climbed 7.4 percent. At that rate, a half-million-dollar retreat today would cost upwards of $700,000 in 5 years. If your goal is to finance 90 percent, your inflation-adjusted savings target should be $70,000, not $50,000.
Buff up your credit rating
As you launch your savings strategy, check your credit rating. Although lenders will typically look for a bigger down payment on a second home, it's entirely possible to front only 5 to 10 percent -- or even nothing at all -- if you're a good credit risk. Scrutinizing your credit report will enable you to correct errors early on that could derail you later. You should also take steps to improve your credit score by paying bills on time and reducing credit-card balances. A good score will ultimately decrease the interest rate on your mortgage, too.
Think Like a Developer
Last year, prices in Tucson, Honolulu, and Miami/West Palm Beach rose by about 25 percent. In Sarasota and Bradenton, Florida, prices were up 30 percent. To get more second home for your money and set yourself up for greater price appreciation after you're an owner, you need to start thinking like a real-estate developer. The pros make money by spotting bargain locations that will be raging in popularity years down the road.
Identify your ideal echo market
The key to finding a more attractively priced market that works for you is to isolate and replicate what you truly love about your first-choice location, says Dave Hehman, president of EscapeHomes.com. Make a list of your second-home must-haves and nice-to-haves, taking into account the setting (beachfront or mountaintop), amenities (fireplace or swimming pool), and recreational goals (boating or snowboarding).
Then test-drive a few alternative locations by renting there at different times of the year. You may find that less-trodden locales -- call them "echo markets" -- offer far better deals, enabling you to get the best of what you love at a fraction of the price (see "Affordable Escapism," on page 97).
Target the worst home on the best block
This developer-inspired strategy may enable you to buy for less money and bring your property into line with the nicest homes in the area, converting sweat equity to home equity. That's what Ted and Brenda Ginsberg did. The Houston-area couple bought a beachfront fixer-upper on Galveston Island, Texas, for $340,000. They took out a mortgage for $414,000 and rolled the difference into much-needed repairs. Today, their beachfront retreat is worth nearly $1 million.
Consider a historic fixer-upper
A certified historic property in need of significant work may be an especially good deal: Under the Fed- eral Historic Preservation Tax Incentive Program, you might be eligible for a 20 percent tax credit if you complete a "substantial" rehabilitation. To qualify, you must be willing to rent out the property and meet a host of other requirements.
For instance, in most cases your rehab expenditures in a 24-month period must exceed the price you paid for the home less the value of the land, after accounting for depreciation and any improvements that were already made. Additional local tax credits vary by state but are usually more substantial. In Arizona, you can cut your property taxes in half by signing a 15-year agreement to maintain a property; in most parts of Hawaii, historic properties are fully exempt from state property taxes.
Become a landlord
The thought of somebody stomping through your vacation pad probably seems sacrilegious, but the difference between hope and reality is an enticing income stream. "More and more people these days are renting out their property to defray operating costs, which have gone up considerably," says EscapeHomes.com's Hehman. Shop strategically. Homes with views and amenities tend to offer better rental prospects than secluded properties, says broker Ken Libby, who chairs the National Association of Realtors' Resort and Second Homes Committee.
In Stowe, Vermont, where Libby is based, a $500,000 home that is centrally located can deliver $35,000 a year in rental income, versus $20,000 for a more private home that is just a half mile away. But don't plan to use it during peak periods: In Stowe, says Libby, "the 10-day period from Christmas to New Year's is a third of your income." If you're willing to settle for nearby towns, says Libby, you could get a $500,000 home for $300,000, but you couldn't count on the rental check.
Buy raw land and build a prefab
Rather than acquiring land and then paying $300 to $700 a square foot to build a high-end residence from scratch, you could spend roughly half that on a prefab home. Once the domain of trailer parks and drab postwar housing, prefab designs now headline museum exhibitions and architecture competitions. "It's the most affordable way to get modern architecture," says Rocio Romero, a Chile-born architect whose LV series of prefab homes start at $120 a square foot.
Any buy-and-build strategy involves risks. Raw land has historically been a solid investment and can sell for a relative pittance, but local zoning rules and a lack of road access and utility lines can create headaches. John McAllister, president-elect of the Realtors Land Institute, a trade association, says buyers should stick with "improved land," which has been plugged in to the local electricity and water grids. Even with prefab, one big wild card remains: the cost of the foundation, which Romero says can run from $5,000 to $100,000, depending on the quality of the ground and the local price of labor.
Conduct a Reality Check
Once you've done some browsing in your preferred location, you need to get a handle on hidden expenses. "People become enamored of the gorgeous beach view and tend to forget about all the costs involved," says real-estate investor Christine Karpinski, author of Profit From Your Vacation Home Dream. To avoid a panic attack at your closing, explore ways to trim costs.
Reevaluate your love of the water
One largely unshakable truth is that waterfront property is going to cost you dearly. Besides the huge price premium, coverage for flooding or hurricane damage, repairs for sun or salt corrosion, even beach-erosion problems will all add to your ongoing expense. "Insurance [for a home] directly on the beach can be $3,000 and up," says Karpinski. "But for the exact property across the street, it might be only $500 to $700."
Don't remind the Ginsbergs. They love watching the sunset over the Gulf of Mexico, but they could do without the hurricane risk: Insurance against flooding, windstorms, and other coastal perils runs them about $10,000 a year on top of their mortgage payments.
Choose a condo
If you're targeting a second home locale that is hours away from your primary home, consider buying a condominium. Yes, it'll cost you more in association fees. But since the price of major repairs is shared and there is usually an on-site staff to handle maintenance matters, the trade-off can be worth it. "The majority of the big stuff that can go wrong -- roofing, siding, windows -- is all covered," says Karpinski. Condos have also proven to be the better investment: Over the past 5 years, for example, they've delivered 14.5 percent appreciation, compared with 8.3 percent for homes.
Consider collective ownership
Buying property with a friend or family member enables you to acquire an ownership share without having to bear the full cost of the purchase or the upkeep -- and you can pass your share to an heir ("tenants in common") or to the other person on the deed ("joint tenancy"). Of course, mixing family or friendship with real estate can be risky. So the first order of business is to hire an attorney to draft a detailed letter of understanding that lays out the ground rules.
"Whether it's who gets to go up this weekend or what happens if you want to paint a room blue, you want an agreement that covers a lot of ground," says Andy Sirkin, a San Francisco real-estate lawyer who specializes in co-ownership arrangements. Be sure your agreement gives you an out. One approach is to guarantee each owner the right of first refusal on the sale of a share after a predetermined standstill period, says William Baldwin, a financial advisor and attorney in Waltham, Massachusetts, who has drafted several arrangements. You could also agree to put the property on the market if neither party wants to buy the other out. "Each party gets a put option," says Baldwin.
Ace the Home Stretch
Lenders typically charge a premium of an eighth to a quarter of a percentage point on second-home mortgages. If you need rental income to make the numbers work, "you've moved over to the investment side of the ledger," says Keith Gumbinger of mortgage tracker HSH Associates. It'll likely cost you another half point. Look for any leverage you can when shopping for a loan.
Play lenders off against each other
Working with the lender who financed your primary home may streamline the application process -- and you're more likely to get a break on fees. Still, experts recommend shopping online and approaching at least two other banks and mortgage brokers to gain negotiating clout. You should also check in with local banks and brokers who can steer you to special deals. Get a preapproval letter for a mortgage from your bank a few months before you are ready to bid on a property.
Immunize your finances
When you finance property with somebody else, you risk losing it if your partner is no longer able to shoulder his or her portion of the mortgage payment. Traditionally, joint buyers have secured a single mortgage together, but the "new wave" in vacation-home financing, says Sirkin, is for each owner to obtain a separate loan backed by his or her fractional interests.
Although the interest rate will be higher to reflect the added complexity, your credit rating and your mortgage payments won't be affected by your partner's financial misfortune. Depending on the arrangements in your letter of understanding, you may still have to buy out your partner or take on a new one if he or she runs into money troubles. Regardless of the loan you choose, cut your risk by checking out your partner's financial qualifications well in advance.
Hire a good accountant
If you rent out your new home fewer than 15 days a year, you don't have to report the income to the government. But if you rent for longer, the IRS categorizes your home as a rental property, not a private getaway, and you must log those extra dollars on your tax return. The good news is that you can write off a portion of major expenses against the income you generate, including electricity, housekeeping costs, and property taxes. These expenses could eat up as much as 30 to 50 percent of your rental dollars, so it's important to maximize your deductions by working with an accountant who knows what he's doing.
Nobody said plotting your second-home strategy would be a walk in the park. It's a task that seems especially daunting given those double-digit real-estate price gains of the past few years. So here's some inspiration: Even amidst the frothiness, the typical second-home buyer is no Rockefeller. According to the National Association of Realtors, Mr. Typical earned $82,800 last year and paid $204,100 for a median-priced vacation pad. If he can make it happen, you can, too. After all, you're no Mr. Typical. And now you're much better prepared. Enjoy the hunt.
That's the price of 7 gallons of gas and a cafe latte.
Why the 5-year target?
Economic reality, that's why. You've got a retirement to prepare for, and you probably have kids to educate. You also need to be ready for any unforeseen financial challenges that crop up. Just as rising interest rates are helping cool home-price appreciation and discourage real-estate speculators, rising rates will boost the return on your savings. A 5-year runway enables you to leverage compound interest to get to your down payment without disrupting your other financial goals. Five years is also plenty of time to explore your second-home alternatives, find ways to trim costs, and turn your real-estate fantasy into reality.
If Lenin could muscle the entire Soviet economy in 5-year time spans, you can marshal your resources and achieve your second-home dream. Here's how to make it happen.
Lay the Groundwork
When you miss a few sessions at the gym, you have to work twice as hard the next time to make any progress. Your motivation might even slip. The same goes for your goal of owning a second home: Relentless dedication is everything. Your strategy begins with a realistic savings plan.
Create your down-payment strategy
To stay focused, open a separate account and call it your "sunny day fund." To enforce discipline, set up a monthly electronic transfer so you can move funds into the account without ever having to think about it. Then drop extra money into the account whenever you can. That's what Ethan and Renee Chandler did.
The Richmond, Virginia, couple started putting money away before they had settled on a location -- or even agreed that they would buy a vacation home. "Over six years, we hoarded any stock options, any bonuses, any pay increases," says Renee, 35. "We reduced all our debt, didn't do big upgrades to the house, and didn't sell those stock options to splurge on something unnecessary." When the time came, the Chandlers easily had enough cash for a 10 percent down payment on a $300,000 two-story gem on the bay in Vieques, Puerto Rico.
Invest your sunny-day fund wisely
There's another good reason to keep your down-payment money separate from funds you sock away for other goals: Your investing strategy should be radically different. As a rule of thumb, you should avoid stocks if you need the money in fewer than 7 years, says financial advisor Shashin Shah, president of SGS Wealth Management, in Dallas. The reason is simple: The market might be slumping just when you need to withdraw funds, forcing you to lock in a loss. Thankfully, rising interest rates mean boring is once again beautiful: A nearly risk-free, high-yield money market account, such as the one offered by online bank HSBCdirect, pays that magic 4.5 percent annually.
One-year certificates of deposit, which are slightly less liquid, are also market beaters: ING Direct, another online bank, offers 5.25 percent with no minimum deposit. If you're in a high tax bracket, adds Harold Evensky, chairman of wealth-management firm Evensky & Katz, in Coral Gables, Florida, you can bump up your returns by moving a portion of your money into a low-cost mutual fund that invests in tax-free, short-term municipal bonds.
Factor inflation into your savings equation
A big variable that affects your down-payment goal is the rate of appreciation in markets where you want to buy. Get a feel for what you're up against by doing some price sleuthing on specialty second-home Web sites like EscapeHomes.com or generalist real-estate sites like HomeGain.com. You can also buy intelligence from an outfit like the Local Market Monitor, a consultancy in Wellesley, Massachusetts, that calculates average prices for more than 100 markets.
With an estimate in hand, back into your savings goal by projecting what a home that you like in today's dollars will cost you down the road. Last year, for example, the median-priced vacation home climbed 7.4 percent. At that rate, a half-million-dollar retreat today would cost upwards of $700,000 in 5 years. If your goal is to finance 90 percent, your inflation-adjusted savings target should be $70,000, not $50,000.
Buff up your credit rating
As you launch your savings strategy, check your credit rating. Although lenders will typically look for a bigger down payment on a second home, it's entirely possible to front only 5 to 10 percent -- or even nothing at all -- if you're a good credit risk. Scrutinizing your credit report will enable you to correct errors early on that could derail you later. You should also take steps to improve your credit score by paying bills on time and reducing credit-card balances. A good score will ultimately decrease the interest rate on your mortgage, too.
Think Like a Developer
Last year, prices in Tucson, Honolulu, and Miami/West Palm Beach rose by about 25 percent. In Sarasota and Bradenton, Florida, prices were up 30 percent. To get more second home for your money and set yourself up for greater price appreciation after you're an owner, you need to start thinking like a real-estate developer. The pros make money by spotting bargain locations that will be raging in popularity years down the road.
Identify your ideal echo market
The key to finding a more attractively priced market that works for you is to isolate and replicate what you truly love about your first-choice location, says Dave Hehman, president of EscapeHomes.com. Make a list of your second-home must-haves and nice-to-haves, taking into account the setting (beachfront or mountaintop), amenities (fireplace or swimming pool), and recreational goals (boating or snowboarding).
Then test-drive a few alternative locations by renting there at different times of the year. You may find that less-trodden locales -- call them "echo markets" -- offer far better deals, enabling you to get the best of what you love at a fraction of the price (see "Affordable Escapism," on page 97).
Target the worst home on the best block
This developer-inspired strategy may enable you to buy for less money and bring your property into line with the nicest homes in the area, converting sweat equity to home equity. That's what Ted and Brenda Ginsberg did. The Houston-area couple bought a beachfront fixer-upper on Galveston Island, Texas, for $340,000. They took out a mortgage for $414,000 and rolled the difference into much-needed repairs. Today, their beachfront retreat is worth nearly $1 million.
Consider a historic fixer-upper
A certified historic property in need of significant work may be an especially good deal: Under the Fed- eral Historic Preservation Tax Incentive Program, you might be eligible for a 20 percent tax credit if you complete a "substantial" rehabilitation. To qualify, you must be willing to rent out the property and meet a host of other requirements.
For instance, in most cases your rehab expenditures in a 24-month period must exceed the price you paid for the home less the value of the land, after accounting for depreciation and any improvements that were already made. Additional local tax credits vary by state but are usually more substantial. In Arizona, you can cut your property taxes in half by signing a 15-year agreement to maintain a property; in most parts of Hawaii, historic properties are fully exempt from state property taxes.
Become a landlord
The thought of somebody stomping through your vacation pad probably seems sacrilegious, but the difference between hope and reality is an enticing income stream. "More and more people these days are renting out their property to defray operating costs, which have gone up considerably," says EscapeHomes.com's Hehman. Shop strategically. Homes with views and amenities tend to offer better rental prospects than secluded properties, says broker Ken Libby, who chairs the National Association of Realtors' Resort and Second Homes Committee.
In Stowe, Vermont, where Libby is based, a $500,000 home that is centrally located can deliver $35,000 a year in rental income, versus $20,000 for a more private home that is just a half mile away. But don't plan to use it during peak periods: In Stowe, says Libby, "the 10-day period from Christmas to New Year's is a third of your income." If you're willing to settle for nearby towns, says Libby, you could get a $500,000 home for $300,000, but you couldn't count on the rental check.
Buy raw land and build a prefab
Rather than acquiring land and then paying $300 to $700 a square foot to build a high-end residence from scratch, you could spend roughly half that on a prefab home. Once the domain of trailer parks and drab postwar housing, prefab designs now headline museum exhibitions and architecture competitions. "It's the most affordable way to get modern architecture," says Rocio Romero, a Chile-born architect whose LV series of prefab homes start at $120 a square foot.
Any buy-and-build strategy involves risks. Raw land has historically been a solid investment and can sell for a relative pittance, but local zoning rules and a lack of road access and utility lines can create headaches. John McAllister, president-elect of the Realtors Land Institute, a trade association, says buyers should stick with "improved land," which has been plugged in to the local electricity and water grids. Even with prefab, one big wild card remains: the cost of the foundation, which Romero says can run from $5,000 to $100,000, depending on the quality of the ground and the local price of labor.
Conduct a Reality Check
Once you've done some browsing in your preferred location, you need to get a handle on hidden expenses. "People become enamored of the gorgeous beach view and tend to forget about all the costs involved," says real-estate investor Christine Karpinski, author of Profit From Your Vacation Home Dream. To avoid a panic attack at your closing, explore ways to trim costs.
Reevaluate your love of the water
One largely unshakable truth is that waterfront property is going to cost you dearly. Besides the huge price premium, coverage for flooding or hurricane damage, repairs for sun or salt corrosion, even beach-erosion problems will all add to your ongoing expense. "Insurance [for a home] directly on the beach can be $3,000 and up," says Karpinski. "But for the exact property across the street, it might be only $500 to $700."
Don't remind the Ginsbergs. They love watching the sunset over the Gulf of Mexico, but they could do without the hurricane risk: Insurance against flooding, windstorms, and other coastal perils runs them about $10,000 a year on top of their mortgage payments.
Choose a condo
If you're targeting a second home locale that is hours away from your primary home, consider buying a condominium. Yes, it'll cost you more in association fees. But since the price of major repairs is shared and there is usually an on-site staff to handle maintenance matters, the trade-off can be worth it. "The majority of the big stuff that can go wrong -- roofing, siding, windows -- is all covered," says Karpinski. Condos have also proven to be the better investment: Over the past 5 years, for example, they've delivered 14.5 percent appreciation, compared with 8.3 percent for homes.
Consider collective ownership
Buying property with a friend or family member enables you to acquire an ownership share without having to bear the full cost of the purchase or the upkeep -- and you can pass your share to an heir ("tenants in common") or to the other person on the deed ("joint tenancy"). Of course, mixing family or friendship with real estate can be risky. So the first order of business is to hire an attorney to draft a detailed letter of understanding that lays out the ground rules.
"Whether it's who gets to go up this weekend or what happens if you want to paint a room blue, you want an agreement that covers a lot of ground," says Andy Sirkin, a San Francisco real-estate lawyer who specializes in co-ownership arrangements. Be sure your agreement gives you an out. One approach is to guarantee each owner the right of first refusal on the sale of a share after a predetermined standstill period, says William Baldwin, a financial advisor and attorney in Waltham, Massachusetts, who has drafted several arrangements. You could also agree to put the property on the market if neither party wants to buy the other out. "Each party gets a put option," says Baldwin.
Ace the Home Stretch
Lenders typically charge a premium of an eighth to a quarter of a percentage point on second-home mortgages. If you need rental income to make the numbers work, "you've moved over to the investment side of the ledger," says Keith Gumbinger of mortgage tracker HSH Associates. It'll likely cost you another half point. Look for any leverage you can when shopping for a loan.
Play lenders off against each other
Working with the lender who financed your primary home may streamline the application process -- and you're more likely to get a break on fees. Still, experts recommend shopping online and approaching at least two other banks and mortgage brokers to gain negotiating clout. You should also check in with local banks and brokers who can steer you to special deals. Get a preapproval letter for a mortgage from your bank a few months before you are ready to bid on a property.
Immunize your finances
When you finance property with somebody else, you risk losing it if your partner is no longer able to shoulder his or her portion of the mortgage payment. Traditionally, joint buyers have secured a single mortgage together, but the "new wave" in vacation-home financing, says Sirkin, is for each owner to obtain a separate loan backed by his or her fractional interests.
Although the interest rate will be higher to reflect the added complexity, your credit rating and your mortgage payments won't be affected by your partner's financial misfortune. Depending on the arrangements in your letter of understanding, you may still have to buy out your partner or take on a new one if he or she runs into money troubles. Regardless of the loan you choose, cut your risk by checking out your partner's financial qualifications well in advance.
Hire a good accountant
If you rent out your new home fewer than 15 days a year, you don't have to report the income to the government. But if you rent for longer, the IRS categorizes your home as a rental property, not a private getaway, and you must log those extra dollars on your tax return. The good news is that you can write off a portion of major expenses against the income you generate, including electricity, housekeeping costs, and property taxes. These expenses could eat up as much as 30 to 50 percent of your rental dollars, so it's important to maximize your deductions by working with an accountant who knows what he's doing.
Nobody said plotting your second-home strategy would be a walk in the park. It's a task that seems especially daunting given those double-digit real-estate price gains of the past few years. So here's some inspiration: Even amidst the frothiness, the typical second-home buyer is no Rockefeller. According to the National Association of Realtors, Mr. Typical earned $82,800 last year and paid $204,100 for a median-priced vacation pad. If he can make it happen, you can, too. After all, you're no Mr. Typical. And now you're much better prepared. Enjoy the hunt.
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