second home vs investment property

Second Home vs Investment Property: How Do the Mortgages Differ?

In Real Estate Investing by Bergan & Company

Real estate is Americans’ favorite long term investment. While the stock market is often glamorized as the way to make it big, the real money is in real estate. If you’re looking to invest in real estate, you’ll have to purchase some property. Chances are, you’ll need to take out a mortgage.

Mortgages for primary residences are significantly different than those for second homes and investment properties. Knowing the differences is important to ensure you make the most of your investment.

Keep reading to learn more about the differences between a mortgage for a second home vs investment property. 

What is a Second Home?

A second home is a property that you purchase with the intent to live in it, even if just for part of the year.

Vacation homes are a common example of second homes. These are often purchased by older homeowners who have paid off their primary home.

Lenders often require that a second home be located a certain distance from your primary residence. Any single unit property that isn’t part of a timeshare agreement can be a second home.

When it comes to tax purposes, a second home is one that you live in at least part of the year and that is rented out for less than 180 days.

What is an Investment Property?

An investment property is purchased with the goal of generating income.

Some people live in their investment properties, but most rent them out. You might rent investment property to someone as a primary residence or as a vacation rental.

For tax purposes, an investment property is any property not occupied by the owner and used solely as a source of income or one that is rented out for more than 180 days of the year. Investment properties include rentals, properties being flipped, and commercial property. 

Mortgages for a Second Home vs Investment Property

In general, mortgages for second homes are easier to qualify for and offer more lenient terms than mortgages for investment properties. Both types of mortgages have stricter credit requirements than mortgages for primary residences.

Here are some of the key differences between the two. 

Down Payments

Down payment requirements are higher for mortgages on investment properties. This is because lenders perceive a higher risk with these borrows.

To offset that risk, the buyer must assume a higher equity stake. Down payment requirements for second homes can be as low as 10%. On the other hand, down payments for investment mortgages may be in the 20-25% range.

Both types of mortgages will require significantly higher down payments than those offered for primary residences. 

Mortgage Rates

Mortgage rates for investment properties are generally higher than those for second homes. This is because lenders view mortgages on investment properties as a greater risk than second homes.

They figure that borrowers are more likely to give up on a failed business venture than a second home.

In general, both types of mortgages have higher interest rates than those offered for primary residences. People are less likely to walk away from payments when it comes to their living arrangements. 

Rental Income

Investment property mortgages have an advantage because lenders often allow anticipated rental income to be applied toward your income requirement.

Lenders may allow up to 75% of the rent you expect to earn to count towards your DTI ratio. This means borrowers have more flexibility than they do with a second home mortgage.

Your lender may require prior experience with property management in order to consider future rent as income. This process may also require extra paperwork and an appraisal of rent prices for the property. 

Requirements to Qualify

Qualifications requirements for a mortgage on a second home include proving the ability to afford your primary home in addition to your second home. You may even be required to have enough cash on hand to make payments on both of your properties for six months.

The requirements to qualify for an investment property mortgage are similar. However, you might also have to prove you have a successful history of property management experience. 

Underwriting requirements will always be more stringent than you’d expect for primary residence mortgages. Lenders tend to be more generous when it comes to first-time homebuyers. 

Tax Benefits

If you earn rental income from an investment property, you must report it as taxable income. On the other hand, rental income from a second home doesn’t count as taxable income so long as your property was rented out for 14 days or less.

If you earn income from an investment property, you can deduct expenses related to renting out and maintaining the property. However, second homes are not eligible for rental expenses deductions.

Owning a second home qualifies you for tax benefits similar to those for a primary residence. These include deductible property taxes, mortgage interest, and mortgage insurance.

It’s worth noting that in 2018, changes to tax law lowered the deductible mortgage amount from $1 million to $750,000 for both types of property purchased after the new law went into effect. 

It’s important to be aware of these tax implications and how your property is classified in the eyes of the IRS.

Looking to Invest?

If you’re interested in property investment, it’s important to know the differences between mortgages for a second home vs investment property.

We can help you understand which is right for you. If you are in need of property management services in the Denver area, we are here to help.

Contact us today to learn more about our property investment and management services.