Ready to buy a second home? Or maybe you want to purchase an investment property. You need to know the difference between the two, because getting a mortgage loan for one is usually a more complicated and costly process.

Lenders usually charge buyers higher interest rates when they are borrowing mortgage money for an investment property that they plan to rent out and eventually sell for a profit. There's a reason for this: Lenders consider loans for these homes to be riskier. Because buyers aren't actually living in these homes, lenders believe that they might be more willing to walk away from them -- and their mortgage payments -- if they suffer a financial setback.

couple in snowThe higher interest rates provide some extra protection to lenders. Lenders will also require that buyers come up with a higher down payment -- usually at least 25 percent of a home's final sales price -- when they're borrowing for an investment property. Again, this comes down to protection. Lenders believe that buyers will be less likely to walk away from the loans on their investment properties if they've already invested more of their own money in these homes.

When you're ready to buy a second home, then, it's important to know whether you're purchasing a second home or an investment property.


Higher rates, down payments

Joe Parsons, senior loan officer with PFS Funding in Dublin, California, said that the interest rates charged on second and investment properties can vary widely. He uses the example of a $400,000 property. If lenders consider that property a second home, a borrower who puts down 20 percent could expect an interest rate of 4.125 percent for a 30-year fixed-rate loan.

But if that same borrower were to buy the identical property as an investment home, the borrower would probably be charged an interest rate of 4.875 percent with the same down payment of 20 percent, Parsons said. If the borrower came up with a larger down payment of 25 percent, the interest rate would probably fall to 4.5 percent, Parsons said.

Down payments are another potential challenge for buyers purchasing second homes or investment properties. Mindy Jensen, community manager with real estate investing social network BiggerPockets, says that you might be able to purchase a second home with a down payment of as low as 10 percent of that home's final sales price. But most lenders will require that 25 percent down payment for investment properties, Jensen said.

Qualifying for a loan for a second or investment property can be challenging, too. That's because you might already have an existing mortgage loan that you are paying down, and those monthly payments are included in your debts.


Second home vs. investment property

But what makes a home a second home or an investment property?

You can consider a second home to be like a vacation home. You're buying it for your own pleasure, and you live in it for a certain period of time every year. If you don't live in it on a semi-regular basis, lenders will instead consider it an investment property.

To qualify as a second home, the property must also be far enough away. Generally, lenders will only consider a property as a second home if it is at least 50 miles away from your primary residence. This might seem odd, but why would your second home, a home that you would consider a vacation home, be located any closer to where you already live?

An investment property is generally one in which you don't live. Instead, you rent it out throughout the year. You might plan on holding the property until it appreciates enough in value to allow you to sell it for a healthy profit. Unlike a second home, an investment property can be located near your primary residence.

"An investment property is one that you purchase with the intention of generating income," Jensen said. "You might use it personally, but it isn't for your sole use. You plan on renting it out, in part of the whole thing, from time to time."

But a second home? That's a different animal.

"You don't rent any portion of it out for any amount of time," Jensen said. "It is solely for you to use. Perhaps you live in one of those cold, northern states, and purchase a second home in a warm, southern state to live in during the winter months. If you don't rent it out during the times you aren't there, that is considered a second home."


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 actually a second home. That way, they can rent out their properties and earn that income without facing higher rates.

Amy Tierce, regional vice president with Wintrust Mortgage in Needham, Massachusetts, advises against this. Lying about whether a home is a second home or an investment property is mortgage fraud. If you're found out, you could face heavy fines.

"Occupancy fraud is growing, and underwriters are trained to sniff out mortgage applications that appear to be for investment purposes although they are structured as second homes in order for the buyer to obtain a better interest rate," Tierce said.

Tierce said that underwriters will first look at where the primary residence is in relationship to the second home.  Some borrowers might live outside of the city, and a second home could be a city condo. Underwriters will make sure that the primary house is far enough away to make sense, Tierce said. A 15-minute drive would not justify owning a city condo to avoid commuting during the week.

Tierce said that buyers can't own two second homes in the same area, even if most of the residences in a community are considered vacation homes. Buyers who do own more than one second home in an area will have to consider the second of their properties as an investment home.

Published on December 8, 2015