How Do Mortgage Requirements Differ For A Second Home Vs Investment Property
The following outlines how the mortgage requirements and guidelines may vary when purchasing a second home or investment property.
- Occupancy requirementsBorrowers must intend to occupy the property for pleasure, whether it be for three months or nine months, to qualify as a second home. A second home cannot be rented out or used as a timeshare. On the other hand, a property is considered an investment property if it is owned but not occupied by the borrower.
- Location requirementsTypically, the mortgage company will require the second home to be located at least 50 miles away from your primary residence, whereas an investment property must be located within 50 miles of your primary residence.
- Down payment requirementsIn general, the down payment requirements for second homes and investment properties are higher than that of a primary residence. However, you may be required to have a larger down payment for an investment property than a second home because investment properties are deemed riskier than second homes. After all, the borrower may rely on tenants income to help cover the mortgage payments rather than their personal income. However, the required down payment may vary based on the mortgage lenders estimated risk, but typically it is 20% of the purchase price.
What You Need To Know
- The key differences between a second home and an investment property are based on occupancy and whether it generates income
- Second homes and investment properties require a better credit score and a higher down payment than a primary residence
- You can deduct property taxes, mortgage interest and mortgage insurance from second homes and investment properties
Selling An Investment Home
To avoid paying capital gains tax on the profit of selling an investment property, homeowners can declare that the funds from the sale will be redirected into another investment property purchase. As long as you file an itemized Section 1031 tax-deferred exchange, the IRS will allow you to defer the payment of your capital gains taxes.
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Turning Your Second Home Into An Investment Property After Closing
Its not uncommon for someone to decide to convert a second home to an investment property at some point. Its best to read your mortgage paperwork to verify there arent any restrictions on how long the home has to be used as a second home to avoid an investigation for occupancy fraud.
Dont forget to report rental income to the IRS when you file taxes. If you decide to refinance, youll be subject to investment property guidelines and interest rates on the new mortgage. That means youll need more equity to refinance and will likely pay a higher rate than you did when the home was classified as a second home.
Second Home Vs Investment Property: Key Differences
Buying a second home can be significantly easier and less costly to finance than buying an investment property. Investment properties can offer you tax deductions by claiming operating expenses and ownership. Second homes, on the other hand, can also generate rental income and tax deductions for expenses, as long as the owner lives there for at least 14 days a year or 10% of the total days rented. Lets break down the differences.
A financial advisor could help you put a financial plan together for buying a second home or an investment property.
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What About Ongoing Expenses
The purchase price of the house is just the starting point. You may want to do an extensive renovation before you move in. Besides the basics like furniture and kitchenware, youâll also be on the hook for recurring expenses like insurance, energy, Wi-Fi and landscape care.
Talk to your financial advisor about what tradeoffs you might need to make to afford these ongoing costs. Your advisor should also run the numbers on some worst-case scenarios, such as having to overhaul the septic tank or covering a steep rise in homeownerâs association fees. âI tell my clients that if they can easily afford those unexpected things, in addition to the cost of the property, and it doesnât put a stress on their budget or put other, more essential goals at risk, then chances are they can afford the home,â Thompson says.
How Will You Finance The Purchase
âInterest rates for second homes typically arenât quite as low as they are for primary home mortgages, and youâll likely need more than the standard 20% down payment,â says Marie Imundo, director, Mortgage Strategy and Execution, Global Wealth and Investment Management at Bank of America. But you can write off mortgage interest on a second home loanâsame as on a primary residenceâup to a combined $750,000 for both residences.
âInterest rates for second homes arenât quite as low as they are for primary home mortgages, and youâll likely need more than the standard 20% down payment.â
However, in a hot market, paying in cash can allow you to move swiftly to nab a home you want, so it might make sense to borrow against investments, using a Loan Management AccountÂ® from Bank of America. âAsk your advisor to help you weigh the pros and cons of different financing options, as well as how the additional outlay might affect your progress to other important financial goals,â Thompson adds.
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Is It A Rental Property Or Second Home
You can rent your second home out for as many as 14 days a year and pocket the income without turning it into a rental property for tax purposes. If you use your second home as both a rental and for personal purposes, you can allocate your deductions between two categories: if you spend 20 days a year in a property that you rent out for 80 days, the IRS treats it 20 percent as a second home and 80 percent as a rental property.
Close On Your Second Home
When the seller accepts your offer, its time to begin closing on the home. The closing process can take 30 40 days, on average, and includes several steps:
Choose a real estate attorney or closing agent. Depending on the state youre closing in, you may need a real estate attorney to handle the settlement and closing paperwork. Your buyers agent can help recommend a trustworthy attorney to best represent your interests.
Buy homeowners insurance. Youll need to confirm proof of your homeowners insurance at closing in order for your lender to release your funding. Shop around for local policies and be sure to review extra damage protection depending on your homes location.
Buy title insurance. Youll also work with a title company to research any outstanding liens on the property to make sure its clear to buy. Your title company will issue title insurance to protect your purchase.
Wait for appraisal results. Your lender will arrange for a home appraisal to ensure your homes value is accurate. If the value is the same or higher than the listing price, youll move on to the next step. If it comes in lower, youll work with your agent to negotiate with the sellers agent and decide if the property is still a worthwhile investment.
Arrange a final walk-through. You fell in love with the home during your tour, but youll want to schedule a final walk-through to ensure the home is move-in ready.
Take the first step toward the right mortgage.
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Second Home Vs Investment Property
Are you buying a second home, or are you making an investment?
This might be confusing, especially if youre thinking about occasionally renting out the property using it regularly for vacation, for example, but also making it available on Airbnb for some of the time youre not using the property and instead are living in your primary residence.
Earning some money from your property doesnt automatically make it an investment, however. Accurately defining the piece of property depends on how much time you spend in it.
Elliot Pepper, co-founder, certified financial planner and director of tax at Northbrook Financial in Baltimore says that you need to pay attention to what he calls the 14-day limit rule.
Very broadly speaking, if you personally live in your second home for 14 days or fewer or less than 10 percent of the days it is rented during a year, then it would be considered a rental property and the income earned would be taxable, Pepper says, but you would also deduct the expenses associated with the property.
On the flip side, if you use the property for more than 14 days or more than 10 percent of the time its rented, any rental income you receive isnt taxable, but you also cant deduct expenses, Pepper says.
In general, a second home is like a vacation home one you purchase for enjoyment purposes and live in during part of the year. In contrast, an investment property is one you plan to rent out with the goal of generating income.
Converting Second Home To Rental Property
As you can see, changing a second home to an investment property, or more particularly, converting a second home to a rental property, is possible, but there are several factors you must consider. Your lender, insurance provider, taxation authority and other government departments all have a vested interest in how you own and use the property.
Importantly, be sure to discuss converting your second home to an investment property with your tax advisor and attorney before making the switch.
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Personal And Rental Use Mortgage Interest Deduction
If your second home is strictly reserved for personal use, you will be eligible for personal mortgage interest deductions. In order to qualify for mortgage interest deductions on a second home, you will need a secured mortgage on a home in your name. Before you can deduct mortgage interest on your tax return, remember to file a Section 1040 IRS form with an itemized record of deductions.
If your second home is intermittently rented out during the year, a number of different tax conditions can apply. Weâve listed the three most common categories for rental use mortgage interest deductions:
- Income from renting the property for 14 days or less does not have to be reported to the IRS. Your second home will still be considered a personal use residence.
- If you stay at your second home infrequently and it is rented out for more than 14 days per year, the IRS will regard the property as a rental home. This means you can deduct mortgage interest payments, homeowners insurance premiums, property taxes, a percentage of depreciation, and property management fees on your tax return.
- If you reside in your second home for more than two weeks per year, the IRS considers the property a personal residence with rental provisions. This means the homeowner can only itemize mortgage interest and property taxes as deductibles on their tax return.
Get Preapproved For A Mortgage
Its important to start the financing process as soon as youre ready to start looking for a home for a couple of reasons. First, starting the process early will eliminate any financial obstacles during the closing process, which will help you close on time with no surprises.
Second, getting preapproved early will give you a better idea of how much you can finance for your home, which is helpful once you start shopping for houses.
You can shop around for local lenders or research options online. Rocket Mortgage® allows you to finance your second home completely online, with helpful tools to guide you through the process. The income verification process is also fast and easy since Rocket Mortgage® allows you to instantly verify your income with online documentation.
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What Is A Primary Property
A primary property is a home you’ll use as your primary residence. When you apply for a mortgage on a primary property or residence, youre confirming youll be living there.
Lenders may feel more confident lending to buyers who are using their home as a primary residence since they will be working directly with the people who are going to be living in, and caring for, the home.
Different Outcomes At Tax Time
What do the tax implications of a second home versus an investment property look like?
Homeowners enjoy the ability to deduct mortgage interest, but Pepper points out that this can get a bit tricky if you own a second home, due to the $750,000 total debt limit for interest deductions. Essentially, if you have more than $750,000 in mortgage debt between the two properties, youve maxed out the amount you can use to deduct interest.
For an investment property, however, the rules are different.
Interest on a mortgage related to an investment property is fully deductible on Schedule E for a taxpayer and can therefore be used to offset any income generated from the property, Pepper says.
In addition to deducting mortgage interest, investment property owners enjoy the ability to deduct a wide range of expenses. The IRS says the following costs are deductible:
- Property taxes
- Advertising the property to attract renters
- Materials and supplies used for the upkeep of the property
If you hire someone to do the work, too, such as a carpenter or an electrician, you can deduct their wages. However, youre not allowed to deduct the cost of a renovation to improve the property.
On the opposite end of improvement, Pepper says that investment property owners can use depreciation to their advantage, as well.
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Second Home Vs Investment Property: Requirements To Buy A House
The risks associated with a second home vs investment property vary. This leads to different requirements to buy a house for each property type.
Just like with any major investment, real estate investors should ask themselves âCan I afford a second home?â before making a vacation home purchase. The answer will determine if you need to turn to a mortgage lender.
Second homes are riskier to lenders. This is why second home mortgage rates are usually higher than those of primary residences. Second home mortgage rates are not the only thing higher than their primary residence counterparts. Down payments, which can range from 0% to 25% for primary residences, are usually at a 20% minimum for vacation homes. Many lenders also mandate that the property be located at least 50 miles away from the investorâs primary residence.
Much of the previously mentioned requirements also apply when buying an investment property. Investment property financing, for example, typically requires a 20 to 25% down payment, although there are plenty of methods to reduce and even eliminate the down payment altogether. Mortgage and interest rates are typically higher for investment properties than primary residences as well since they generally carry more risk. Investment property financing, however, is broader than vacation home financing. There is a myriad of options available to finance rental properties. The same cannot be said for second homes.
Second Home Vs Investment Property: The Lenders Perspective
Bank lenders strictly define the two property types. Why? Well, because the risk profile and financing for a second home is a lot different than it is for, say, a property youre buying to put on Airbnb or rent out short-term as corporate housing or student housing.
Because a second home mortgage isnt significantly different from a primary home mortgage they both typically have market interest rates and identical credit and income requirements its a lot easier to get a mortgage for a second home than it is for an investment property.
An investment property mortgage comes with a higher interest rate , and will likely require a larger than usual down payment: up to 25%. The credit and income requirements will probably be more stringent, as well. You may also have to prove you have enough cash on hand to cover the first six months of payments, if not longer.
Lenders figure that in times of financial adversity, investors are much more willing to walk away from investment properties than their other properties. In short, investment properties are simply riskier for the lender as well as yourself.
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Obtaining A Mortgage For A Second Home
Second home loans may have higher interest rates than primary residences because they represent a greater level of risk. Because youre not dependent on your second home for a place to live, lenders assume that you may be more likely to stop making payments on the loan if you fall on hard times.
To qualify for a second home mortgage, you may also have to meet higher credit score standards, have a down payment of at least 20%, and meet specific cash reserve requirements. Reserve requirements mean you must have enough money in liquid savings to cover the mortgage for a few months if need be.
Second Home Mortgage Rates And Investment Property Mortgage Rates Faq
What is a second home?
Homeowners live in their second homes for at least a portion of the calendar year. Although each mortgage lender will have their own eligibility requirements, the IRS says a second home is a residence that you visit for at least 14 days each year, or 10% of the total days that you rent it out.
What is an investment property?
An investment property is typically a rental property or a home purchased to renovate and flip for a profit. They differ from second homes in that the buyer does not usually reside in an investment property. Additionally, they can also be larger than oneunit properties.
Are second home mortgage rates always higher?
While its impossible to answer this question without knowing the rate on your existing mortgage loan, second home mortgages and investment properties typically have a higher interest rate. Of course, whatever rate you qualify for will vary depending on your income, credit score, location, and more.
What are alternative ways to finance a second home?What are the risks of a second home mortgage?
Being unable to make the monthly payments on a second home mortgage or investment property loan is among the biggest risks for homebuyers. This is why its important to shop your second mortgage around to find lower interest rates and favorable loan terms to get modest monthly payments. Also, watch out for higher mortgage interest fees even small increases to your rate can become a burden during the lifetime of a loan.
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