How Does a Second Home Impact Finances?

Buying a second home can be challenging because of the higher interest rate and larger down payment.

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Owning a second home can impact your finances in negative ways. For one, when purchasing, be prepared for a larger down payment than you would on a primary home. There will be two mortgages, higher insurance, and higher utility costs. There are also tax implications.

However, despite these additional expenses, according to the National Association of Home Builders (NAHB), 6.5 million homes in America are second homes. How badly do these expenses hurt your finances?

Larger Down Payment on Second Home

The allure of a second home where you can spend the winter is strong, but there are financial considerations.

It starts with qualifying for a new mortgage, which is a little more challenging with a second home. According to The Mortgage Report, if you want to finance, mortgage rates are usually about 0.50 percent higher than market rates.

That’s not the only financial hurdle; be prepared for a larger down-payment requirement. According to The Mortgage Report, the minimum down payment is typically 10 percent. And you'll still need to pay closing costs, which run at 3–5 percent.

In contrast, according to the Federal Housing Administration, a first-time homebuyer is required to have a 3.5 percent down payment.

2 Mortgages With a Second Home

You’ll be taking on another monthly mortgage payment. So, unless you’ve paid all cash or your primary home is paid off, this is a significant financial commitment.

According to the Bureau of Labor Statistics, in 2023, housing costs accounted for 32.9 percent of total monthly expenses. That’s roughly one-third. If you double that expense with a second home, you’ve taken a hefty chunk out of your monthly income.

A Second Home’s Tax Implications

The 2017 Tax Cuts and Jobs Act (TCJA) impacted homeowners. It capped some tax benefits.

For example, the State and Local Taxes (SALT) deduction allows taxpayers to deduct specific local taxes on their federal return. Some examples of local taxes include real property taxes, personal property taxes, state income taxes, and sales taxes.

But before the TCJA, there wasn’t a cap on the amount of deductions you could take. But the TCJA capped it at $10,000. That means if you’ve already hit that $10,000, you cannot deduct additional property taxes from your second home. If you haven’t hit that amount, then you can deduct the difference.

The TCJA expires on Dec. 31, unless Congress extends it.

Mortgage-Interest Deduction

Unfortunately, if you’re buying a second home for personal use, you may be restricted on what mortgage interest you can deduct on your federal income tax return.

According to the IRS, you can deduct home mortgage interest on the first $750,000 of indebtedness. That means if you have a primary residence with a $700,000 mortgage and a second home with a $250,000 mortgage, you can only deduct interest from $750,000. The remaining $200,000 with its interest can’t be deducted.

However, if you have mortgage interest from indebtedness that was incurred before Dec. 16, 2017, the $1 million higher limitation will apply.

Capital Gains for Second Home

A primary residence can exclude up to $500,000 in gain ($250,000 for single filers) from capital gains taxes when you sell it. This exclusion doesn’t apply to a second home if you haven’t lived in it as a primary residence.

But if you spend more than half your year in the second home, it could qualify as your primary residence.

So, if you expect to sell your second home in a few years, one strategy is to qualify the second home as your primary residence for two years before selling. Talk to your tax adviser to develop a plan.

Renting Your Second Home

Many people rent their second home part-time to finance it. But if you want to receive rental property tax deductions, there are specific rules. You must ensure that it is a rental and not your residential property. That’s where the 14-day rule comes into effect.

According to the IRS, the dwelling is considered a residence if you use it for personal purposes during the tax year for 14 days or more. Another benchmark is if you stay in it, 10 percent of the total days you rent it to others at a fair market price. The larger number is the amount of time you’re allowed.

So, if you’ve rented the house for 270 days in a tax year, you could reside in it for 27 days. The 27 is larger than the 14 and is allowed. By doing this, you can take advantage of rental property tax advantages. But if you go over the allowed days, it’s considered a personal residence.

The exception to this is if you’re staying in the house to renovate or make repairs.

Owning a Second Home Can Be Rewarding, but Expensive

Buying a second home can be challenging because of the higher interest rate and larger down payment. Tax laws don’t favor second homes.

But you can take advantage of some deductions by renting your second home. You'll just need to be careful how often you stay in it.

Talk to a tax adviser and determine your best strategies for buying a second home.

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