Tom Kelly: Second-home owners look to alternative financing

Many second-home owners – especially those in the full-time vacation rental business – are looking to purchase another property but are facing stringent financing guidelines. The same challenges, even with low interest rates, are plaguing first-time investors seeking to get started.

Christine Karpinski, the author of “How to Rent Vacation Properties by Owner and Profit From Your Vacation Home Dream,” offered financing observations:

Yes, it’s cheaper to borrow … but it’s also much tougher. The easy money days are over. In fact, you probably already know loans are not easy to get in the post-housing crisis economy. If you plan to take out a mortgage on that vacation home you want, be prepared to put more money down – 20%-30% is the going rate for investment properties.

Homeowner associations and building associations are under the microscope. Lenders are scrutinizing these associations more closely than ever. When members were unable to pay their monthly dues during the throes of the housing crisis, many homeowners’ associations went in the red. Lenders are conscious of these problems and don’t want to lend money for a building or property where there is no money to take care of it.

Expect appraisers to be more stringent than they once were. This is actually a bittersweet thing for the buyer because it means the appraisal amount will be more accurate (i.e., not inflated) than it might have been years ago.

Other alternative methods for financing include reverse mortgages, individual retirement accounts, tax-deferred exchanges from commercial properties and seller financing.

A reverse mortgage historically has enabled senior homeowners to convert part of the equity in their homes into tax-free funds without having to sell the home, give up title or take on a new monthly mortgage payment. However, money may be used for any reason. Reverse mortgages are available to individuals 62 or older who own their home. The maximum amount of money received is based on age, current interest rates and a current home appraisal. Funds obtained from the reverse mortgage are considered tax-free.

The rules for purchasing real estate with an individual retirement account are specific and differ greatly from those that govern conventional rentals and second homes. For example, you cannot buy a second home with an IRA and use it partly for personal use, even though you might rent it to unrelated people the rest of the year. And, an IRA cannot purchase a real estate asset and then have a “disqualified” person (family member) use it while it is in the IRA. The purchase must be for an investment property and no personal use – until retirement. Then, the individual can move into the property and pay tax as if taking a disbursement from a conventional account.

A tax-deferred exchange, commonly known as IRS Section 1031 Exchange, is really an arms-length sale and purchase. The transaction proceeds just as a sale for you, your real estate agent and parties associated with the deal. However, provided you closely follow the exchange rules, the IRS will “sanction” the transaction and allow you to characterize it as an exchange rather than as a sale. Thus, you are permitted to defer paying the capital gains tax.

An exchange occurs when you trade real property other than your home or second residence for other “like kind” real property that you have held for trade, business or investment purposes. The like-kind definition is very broad. You can dispose of and acquire any interest in real property other than a home or a second residence. For example, you can trade raw land for income property, a rental house for a multiplex, or a rental house for a retail property.

The clarity on exchanges came as good news for a longtime reader who said she now plans to trade an old convenience store site for a golf-course home.