Mortgage Rules Differ for Second Homes vs. Investment Properties

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Every mortgage application includes answering the question of how the property you will use the property you intend to purchase. You must declare if the property will be a primary residence, second home, and investment property. 

How you answer is important in determining how much down payment you’ll need and what mortgage rate you’ll qualify for. Each of these also has different requirements before the mortgage can be approved.

Definition of a Second Home

A second home is a property you purchase in addition to your current home that you intend to live in for part of the year. 

Lenders may require proof the property is at least 50 miles from your current residence and will be used as a vacation home, an alternative residence used for work, or a small apartment or condo known as a pied-à-terres. According to the IRS, you must live in the second home for more than 14 days per year or 10% of the total days you rent it to others.

The second home must be a one-unit property and not fall under a timeshare agreement.

Definition of an Investment Property

Investment properties are residences purchased to earn rental income or flip and sell for a profit. These can be multi-unit properties or commercial properties, and you can purchase several of these as a wealth-building strategy by collecting rents and through property appreciation.

Lending Requirements

Lending requirements for second homes and investment properties are more stringent than they are for primary residences.

Lenders charge higher interest rates due to the increased risk that borrowers can walk away more easily from these types of properties. To compensate, lenders often mark up rates by .50 percentage points or more, especially with a lower credit score and a smaller downpayment.

Many lenders also require a minimum credit score of 720 for a second home purchase and 700 for an investment property if you make the lowest allowable down payment. 

You may also be asked to prove that you have enough reserve cash to cover the second home’s payments for up to six months.

Another challenge is that when you have an existing mortgage loan that you are paying down, those monthly payments are included in your debts, raising your overall debt-to-income ratio.

Requirements for Second Homes

The typical minimum second home down payment is 10%. Also, you can’t use an FHA loan or a VA loan to purchase a second home.

Lenders usually require that a second home is at least 50 miles from your primary residence because it does not make sense to live in a second home that is located close to your primary residence. For example, a perfect example of buying a second home could be if you live in a cold northern state and purchase a second home in a warm southern state to live in during the winter.

Buying a second home to use as a rental property has several advantages. The most notable of these are the tax deductions. 

You can take advantage of second home tax deductions if:

  • You live in the property for at least 14 days per year. 
  • You reside in the house for at least 10 percent of the days it is rented out. 

For example, when you rent out a second home for 200 days and live in it for at least 20 days a year, you’ll qualify for tax deductions. While you can generate rental income, the trade-off is that you become a landlord with responsibilities that require time and energy.

Rental income is not usually taxable if the property is rented for less than 14 days per year. And mortgage interest, property taxes, and mortgage insurance are tax deductions.

Requirements for Investment Properties

Lenders generally require a 15%-20% down payment for a single-family home investment property purchase. If you’re buying a two- to four-unit multifamily investment home, you’ll need up to 25% for the down payment.

Financing an investment home will likely involve paying the lender more interest and additional fees. To offset this, borrowers can often use the projected rental income to help them qualify for an investment mortgage.

In most cases, the rental income on an investment property can’t be used to qualify unless your tax returns show you have property management experience. If you can do this, you may add up to 75% of the expected rental income to offset the mortgage payment on the investment property you purchase.

However, lenders that offer this option may require a specialized appraisal that analyzes comparable rent prices in your area.

An exception to this is that FHA guidelines allow FHA-approved lenders to apply anticipated or actual rental income on a two- to four-unit property to your total income, even if you have no landlord experience. You must live in one of the units for at least 12 months to be eligible for this financing option.

Unlike a second home, which usually requires that it be at least 50 miles from your primary residence, an investment property can be located near it.

You can write off mortgage interest, maintenance, utility bills, and depreciation with an investment property. Rental income must be reported if you rent the property for more than 14 days per year.

Don’t Try to Trick Your Lender

Because lenders charge higher interest rates for investment properties, some borrowers might be tempted to trick their mortgage providers, claiming that their investment property is a secobuy That way, they can rent out their properties and earn that income without facing higher rates.

The bottom line is don’t do it! It’s fraud, and you could face heavy fines and other legal consequences if you’re caught.

Occupancy fraud is growing, and underwriters are trained to sniff out mortgage applications that appear to be for investment purposes, although they are presented as second homes. 

Borrowers typically sign an occupancy affidavit at closing, which gives the lender the right to foreclose on a loan if they discover a borrower intentionally misrepresented the use of the property.

Mortgage companies also use high-tech digital verification systems to search for evidence of mortgage fraud. Others schedule random site visits to confirm who is living in the home.

Underwriters will look at where the primary residence is in relation to the second home. Some borrowers might live outside the city, and a second home could be a city condo a short distance away.

Buyers who own more than one home in an area will have to consider the second of their properties as an investment home.

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