As Americans navigate a hot and complex real estate market in an attempt to make wise financial decisions, a new trend is emerging. Many shoppers are turning homebuying on its head by purchasing their “second home” first.
It makes sense for some people. Someone who works in technology, for instance, may be earning a sizable salary but not enough to purchase a home in such high-cost cities as Seattle, San Francisco or New York. A recent report from The New York Times noted that while there isn’t data to track this trend, real estate agents and industry observers are seeing it happen.
There are multiple reasons why potential borrowers might apply for a mortgage on a property that won’t be their primary home. Mortgage originators will want to pay close attention to this trend to understand the opportunities and desires of potential clients.
Record-high home prices and rising interest rates have put a home purchase out of reach for many. According to Realtor.com, the U.S. median listing price hit $405,000 this past March, up 13.5% from one year earlier. The same month, Redfin reported that one in three renters couldn’t afford to buy a home where they wanted to live.
Although price appreciation is a boon for sellers, it can put homeownership out of reach for many. So, doing things in reverse may be a solution for renters who feel priced out of the real estate market.
For instance, keeping a rental home in the city and buying a property a few hours away or in a popular vacation destination may allow a buyer to find an affordable option. Compared to the cost of purchasing a single-family home or condominium in a pricey neighborhood, owning one in a less expensive area may give a potential borrower more square footage and acreage without stretching their finances.
Meanwhile, the COVID-19 pandemic caused many people to reevaluate their priorities, seek more space and get creative. The self-employed and anyone who works remotely may enjoy spending time in multiple places throughout the year.
Instead of waiting until retirement to travel or be nomadic, why not enjoy a rental and a second home? Splitting time between properties may offer a change of scenery, seasonal benefits and more recreation options. It also could allow buyers to be closer to friends, family or work colleagues.
Additionally, buying a “second home” first offers a chance to generate rental income, if the owner chooses to rent out their second home for a portion of the year. Some renters choose to stay put and buy a property for short-term rental purposes on Airbnb or VRBO. Or they might find a long-term tenant to help cover expenses.
There are various ways renters can earn income from owning a second home. Some buyers may choose a multifamily property for their second home, spending time in one unit while renting out the others. Other people may be searching for an undervalued property to fix up and sell for a profit.
Buying an affordable second home in a popular area increases the likelihood that its value will rise. While there’s no guarantee, having some price appreciation gives buyers additional equity to leverage. For instance, they could use the equity for a cash-out refinance to complete renovations or to make a larger downpayment on a primary home.
Some renters may buy second homes to move into when the time is right. For instance, parents may buy a small condo in a walkable city to live in after their kids move out. Or a buyer might find the perfect home in a town where they plan to retire in several years.
Depending on where renters buy a second home and how much time they live in it each year, they could declare residency in a low- or no-income-tax state, such as Texas or Florida. Becoming an official resident in a tax-favorable state could add up to significant savings.
The benefits of buying a second home first depend on a borrower’s financial situation, desired lifestyle and goals. But there also are downsides they need to understand fully.
One disadvantage that many people may not be aware of is that purchasing a non-owner-occupied home isn’t the same as buying a primary residence. It may disqualify them for certain benefits, such as qualifying for downpayment assistance or getting a Federal Housing Administration loan.
Buyers also may not know that a mortgage for a non-owner-occupied home typically requires a higher downpayment and interest rate. This means they may not qualify to borrow as much as they expect.
Plus, operational expenses (such as landlord insurance, property taxes, maintenance, repairs and management fees) could result in an unexpected negative cash flow without careful planning. Mortgage professionals must explain the pros and cons of renting versus buying, and how the costs of owning a second home compare to those of a primary residence. ●