So, you have decided to take the plunge and purchase a boat; how exciting! But, how will you pay for it? Before diving into buying a boat, carefully consider your finances and budget1 to be sure you can afford the next step2.
Remember, the cost of owning a boat is more than just the boat itself. Insurance, fuel, and maintenance are all added costs of boat ownership3. Depending on where you plan to keep your boat, there may be storage or docking costs to consider as well. As with many new purchases, there will likely be plenty of accessories and gear you will want to add to the fun of your new boat.
After considering all the costs, your current budget, and savings, you should have an idea of what you can afford, both on an ongoing monthly or yearly basis and as an up-front payment. Whether you chose to finance the purchase, use cash, or a combination of both, depends on many factors, including:
- Age of the Boat – Many lenders will shy away from older boats, so if the boat you have your eye on is more than 10-20 years old, you will want to confirm financing is available with a particular lender. Loans for older boats may also carry higher interest rates and larger down payment requirements. While the initial cost of an older boat tends to be lower, keep in mind an older boat may come with more maintenance and expenses.
- Type of Vendor – Boat dealers often have their own financing departments, making lenders easily accessible and the process more seamless. However, shop around for rates before accepting the rate quoted to you by the dealer to be sure you are getting the best rate. If purchasing your boat in a private sale, you will want to shop around to obtain the best interest rate. Research online lenders like LightStream that offers an online application, has no collateral requirements, and often provides same-day funding.
- Credit Score – The higher your credit score, the more likely you will be approved for a loan. Having a higher credit score often comes with lower interest rates as well. Depending on your timeline, it may be best to focus on increasing your credit score4 before applying for financing if you think this may be a limiting factor.
- Down Payment – Depending on the lender, there may be a minimum down payment requirement anywhere from 0-20% of the cost of the boat. Depending on how much you have already set aside for the purchase may limit your options.
- Debt to Income Ratio – During the underwriting process, your debt-to-income ratio5 is a critical factor in determining what you can afford, according to the lender. To minimize the risk of default, the lender will want to make sure you have sufficient income to cover all your debts, including the boat loan’s new obligation. Having a stable income to cover your expenses is key to taking on an additional debt obligation.
- Net Worth – Your net worth gives your lender an idea of how much money you have to cover expenses and the down payment for your purchase. If you own a home, the equity value in the house can be a source of financing the boat through a Home Equity Loan.
A boat loan is similar to a car loan in that it is often secured by the value of the boat and can be for both a new or used. If you were to stop making payments, the lender could claim your boat to cover your debt. This type of debt usually carries a lower interest rate than an unsecured one since it is less of a risk for the lender. Because the boat’s loan is secured, the boat’s value, age, type, and condition can all play a role in the underwriting process. Some lenders, like LightStream, offer unsecured boat loans.
Banks and credit unions provide boat loans, so it would be a smart place to start to ask your local branch what they offer. Depending on the lender, the terms, such as length and interest rates, can vary. Some specific lenders specialize in boat loans, such as Chesapeake Financial Services, Inc. or Boatloan.com.
If you find the boat of your dreams at a boat dealer, you may want to look into financing directly through the dealer. Dealers typically have their own financing department with plenty of experience in such loans and can help make the purchasing process go smoothly.
Some boat lenders may have minimum down payment requirements ranging from 0-20%, yet keep in mind, there are advantages to paying more money upfront or as a down payment. For one, the amount you will need to borrow is less, which means less interest charged over time and a lower monthly payment. With most boat loans ranging from 3 to 7 years in length, a shorter loan period will generally mean a lower loan interest rate being charged.
A personal loan is unsecured, meaning it is not tied to the boat’s value in any way. Since there is no collateral attached to the loan, it is seen as riskier for the lender, and as such, the lender will typically charge a higher interest rate to compensate for the higher risk. To qualify for a personal loan, a high credit score and solid income are imperative.
While a personal loan typically has a higher interest rate compared to a secured boat loan, there are some instances where the personal loan is a solid option to consider. For example, if you have your eye on something classic, a boat loan may not be an option for you due to the age limitations from some lenders. Another potential advantage of a personal loan vs. a boat loan is that there are no down payment requirements. This also gives you the ability to secure funds for your purchase ahead of time while you shop for your boat; that way, once you find one that meets your needs, the purchase can be simplified.
HOME EQUITY LOAN
Another alternative, if you have equity in your home, is to take out a home equity loan. Interest rates on home equity loans tend to be lower than boat loans and personal loans and are secured by the value of your home rather than the boat. Using a home equity loan can offer some of the same advantages of a personal loan in that if the boat you have your eye on is older, through a private seller, or down payment requirements limit you, this may be a more convenient option. A potential downfall of the Home Equity Loan is that it does take time to process. So, if you already have a boat picked out, this option may take too long, depending on the seller.
Keep in mind that interest on the Home Equity Loan used to purchase a boat will generally not be tax-deductible unless it meets the requirements under IRC Section 163(h)(4) and is capped at $100,000. See IRS Publication 936 for additional information.
TAX DEDUCTIBILITY OF BOAT LOANS
Suppose your boat contains basic living accommodations such as a sleeping space (berth), a toilet (head), and cooking facilities (galley). In that case, you may be able to deduct the interest you pay on your boat loan under IRC Section 163(h)(4) as one of two qualified residences the IRS allows for purposes of deductibility. Other restrictions apply.
Chartering your boat. If you plan on using your boat for charters, to obtain a tax deduction for the interest paid on your boat loan, you will have to use the boat for personal purposes for either more than 14 days or 10% of the number of days during the year the boat was chartered, per IRC section 280A(d)(1).
Note, if you plan on using your boat as a business through charters, you can deduct against your charter income and other employment income all ordinary and necessary charter-related expenses. These include slip fees, insurance, repairs, loan interest, property tax, etc.
While some debt can be seen as a financial tool and considered a “good debt” 6, it can be risky when used to make discretionary purchases. Using debt to finance a boat purchase comes with the added cost of interest. Boats are a depreciating asset, so not only are you losing interest on the debt, but the value of the boat itself used to secure the loan is also diminishing in value over time. This can put you at risk of being “upside-down” on your loan, meaning you owe more than you have equity in the boat.
Some boat lenders have minimums, typically $10,000 – so if the boat you are considering is a lower cost, you may need to pay with cash.
To have the funds set aside for the purchase of the boat can be a great feeling. By paying in cash, you can minimize the impact on your budget by not worrying about monthly finance payments and avoiding the costs of interest charges. Therefore, it may be best to save your pennies until you can purchase a boat outright with cash. To start saving today, set yourself a goal and create a budget of what you afford to set aside each week or month. For example, to save $10,000 in just two years would mean setting aside $416 each month. This calculator7 can help you determine what you need to set aside monthly to meet your savings goal.
When using cash, however, it is important to consider the opportunity cost. Instead of using cash toward the purchase of the boat, it could be invested. Depending on the rate of return and your investment profile, you may feel you can earn more by investing than the interest being charged on the debt; in that case, you are leveraging your resources for the better, and taking a loan may be advantageous.
It is also important not to wipe out your emergency savings for the purchase of a boat. It is not recommended to make a discretionary purchase if it limits your liquidity. It is essential to have an adequate emergency fund of at least 6-12 months of expenses in place in addition to any cash you may want to use in purchasing your boat or using as a down payment.
There are many factors to consider when purchasing a boat to determine which option is best for you. With careful planning and budgeting, hopefully, you will be enjoying the open water feeling confident you made the right choice in financing your purchase.
The information provided in this article is for general purposes only and should not be construed or used as tax, financial, investment, or other professional advice. If you have questions regarding your financial situation, you should consult your tax professional, financial planner, or investment advisor.