Rent is a waste of money, isn’t it? That is what we have been conditioned to believe for the past few generations. Even when the real estate market is more stable and prices are constantly increasing, buying a vacation home may not be the best decision on your budget.
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 effective cost of $12,000 per month ($36,000/3). You could rent a similar house in the same area seasonally for $4,000 per month or $12,000 per season. You would be paying an extra $24,000 a year to own the home instead of renting it ($36,000-$12,000). Over five years, you would have spent $120,000 more to own the home ($24,000 x 5 years). Yes, the house could appreciate, but you would have to subtract your buying and selling closing costs 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 (above 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 from the sale, you would net about $471,900. Your approximate profit would be $63,900, but remember that you would have spent an extra $120,000 to own rather than rent the house for those five years, which would actually mean you spent $56,100 more overall (-$120,000 + $63,900). .
Keep in mind that the house could have needed repairs and renovation work, which would have added to your cost as a holiday home owner. However, you would pay off 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 interest on this second home mortgage, 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 perform 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 factor into your decision. However, it’s better to make a big financial decision with your “eyes wide open” than with blinders on. You can avoid disappointment or financial difficulties later.
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 adviser.
