Should we buy a holiday home?

Summer is here, and you should be relaxing somewhere with lots of sunshine and blue skies. It is at these times when we are walking along the beach with our partner and have plenty of time to reflect that thoughts like “wouldn’t be nice to spend more time here” may pop into our heads. What is the cost of buying a holiday home?

Real estate agents have windows that are brightly displaying all the possibilities to fulfill your desire. You are probably the most cautious and prudent member of your tribe as you listen to Financial Autonomy. So, it is likely that your thoughts will turn to factors to consider when buying a holiday home.

In the past, I have worked with clients who bought holiday homes. This week, I would like to share some of my observations.

Let’s give a shout-out to the team at Ambulance Victoria before we get started. I’ve heard that you have been mentioning us in your group chat. Thank you for listening and for the hard work your colleagues and yourself do around the country, especially during this time of the year.

First, ask yourself if you can afford it. Holiday houses are a nice-to-have but not a necessity, so you’d only buy one after you have a comfortable home. It would be ideal if the house were fully paid for, but it could also mean that you have a small amount of debt in relation to the value.

If you are borrowing money to purchase this property, you should first determine how much you can afford to pay each month towards the new mortgage. After you have agreed on this figure, you can use the calculator found on the MoneySmart website to calculate how much you could borrow and, therefore, what you could afford to spend for a holiday home.

You may not need to pay a deposit if you have accumulated significant equity.

When determining the affordability of a vacation home, it is common to assume that the property will be rented in the first few years until the debt has been reduced to an affordable level. Airbnb has made short-term rentals more feasible.

It can be a very effective approach for properties that are in the right place. My client has a property that is pretty much booked all year long in Bright. Other clients’ properties are rarely booked, even though they may be beautiful and peaceful. They also tend to be quite remote, with not much around them that would attract people. I’ve also seen holiday homeowners in areas with a huge supply of homes. While they may get rented during the summer season, the income is negligible for the remaining eleven months.

It would be best if you were very careful when calculating the potential income from holiday rentals. You will need to factor in cleaning costs and the cost of an agent, as well as wear and tear and damage on your property. In addition, there is an increasing tendency for state governments and local authorities to tax short-term rental properties. Your holiday home may be less profitable than you first thought.

The increasing impact of the land tax in Australia is another significant factor that impacts affordability. Land tax makes sense from a social equity perspective, as it is reasonable to ask someone who has enough wealth to buy a second house to pay a little more into society. If you are the owner of the home and receive a bill of thousands of dollars, it might not be easy to accept this as social justice.

You will have to take into account how the purchase of a holiday home will impact your usual holiday expenses when determining your affordability. You can assume that you will spend less on your holidays if you stay at your vacation home instead of traveling. You may not want to return to the same holiday destination every year, so it’s important to consider the long-term effects.

If you are able to overcome the affordability barrier, you will now be exposed to another important asset, and most likely one that is geared. In this situation, capital growth could have a significant impact on your wealth. I have seen people who bought holiday homes along the coast many decades ago. They lived in the house with their family and enjoyed it for many years. Then, when they retired, the value of the home was more than the primary residence. This is not a guaranteed outcome and usually occurs only after a long period where the property value has stagnated. In comparison with normal holiday spending, however, the money invested in paying off a vacation home can have a long-term financial benefit.

It would be best if you also considered the ownership of the property. It should be owned in your joint name or one of your names. A family trust is another option. It is best to seek advice specific to your situation. The balance is to be struck between capital gains tax and the possibility of negative gearing if the property is rented out most of the time. It makes sense to put the property in the name of the person who pays the highest tax rate if the property will be used as a vehicle for negative gearing. If you are expecting the property to become positively geared or sold in the future, triggering capital gains taxes, the ownership should be held by the person with the lowest income. You could have more flexibility with a trust structure, but be aware of the implications for land tax and additional accounting costs. Often, the costs of flexibility outweigh any benefits.

I’ve seen a few instances where the holiday house was used to facilitate a retirement move. This usually involves the demolition of the holiday home and building a new permanent residence. This can lead to a wonderful outcome. It is exciting for the couple who are entering retirement to design and build a home tailored to their needs and those of their family. They know their neighborhood, are familiar with it, and have a good understanding of what they’re doing. Capital gains taxes are not applicable to the sale of their capital city home. They may also be able to use the downsizer contribution rule to grow their superannuation funds. The land block is often larger than suburban properties, allowing for a grey nomad caravan and other hobbies.

A holiday house can be both a great way to create wonderful memories with your family and a smart financial decision. There are pitfalls with every investment. In a transaction such as this, where you will be borrowing money, it is important to be realistic and aware of the risks.