Rent is a waste of money, isn’t it? That is what we have been conditioned to believe for the last few generations. Even when the real estate market is more stable and prices are constantly rising, buying a vacation home may not be the best decision for your pocketbook.
Should you buy a vacation home that you will only use a few months of the year? Let’s take a look at a simplified example to highlight what it costs to own a vacation home. You buy a vacation home and the monthly costs, including mortgage payment, property taxes, insurance, HOA or other maintenance and utilities, are $3,000 per month. You use the house for three months out of the year, even though you are paying for 12. So, you are paying $3,000 a month for 12 months, or $36,000 a year, and you use the house for three months at an actual cost of $12,000 per month ($36,000/3). You could seasonally rent a similar house in the same area for $4,000 per month or $12,000 per season. You would be paying an extra $24,000 a year to own the house instead of renting it ($36,000-$12,000). Over five years, he would have spent an additional $120,000 to own the house ($24,000 x 5 years). Yes, the house could appreciate, but you would have to subtract the closing costs of the purchase and sale and a possible real estate commission from any appreciation.
Let’s say you bought a home for $400,000 plus $8,000 in closing costs for a total initial investment of $408,000. Let’s assume it increased in value by 5% a year (higher than normal market conditions). It would be worth approximately $510,500 at the end of the fifth year. If you sold the house and subtracted a 6% commission and $8,000 in closing costs, you would net $471,900. Your approximate profit would be $63,900, but remember you would have spent an additional $120,000 to own rather than rent the house during those five years, which would actually mean you spent $56,100 more overall (-$120,000 + $63,900) .
Keep in mind that the house might have needed repairs and renovation work, which would have added to your cost as a vacation home owner. However, you would pay part of your mortgage balance, which would be a benefit of owning instead of renting. But know that during the first few years of a 30-year mortgage, typically 75% – 80% of each payment is interest, not principal. You may also be able to deduct the mortgage interest on this second home, but the bottom line is that for this vacation home, the overall financial costs would outweigh the benefits.
Every situation is different, but now you have the tools to do your own financial analysis. Sometimes it makes financial sense for you to buy rather than rent a vacation home, and sometimes there are non-financial reasons that influence your decision. However, it’s better to make a big financial decision with “eyes wide open” than with blinders on. You can avoid disappointment or financial difficulties later on.
Please note that all information in this article is educational and should not be construed as financial advice. For advice specific to your needs and circumstances, you should consult a financial or tax advisor.