Mortgage rules differ for second homes vs. investment properties

Dan Rafter
Written by
Dan Rafter
Read Time: 7 minutes
share

Primary Residence Mortgage Rules

Every mortgage application you complete will involve you answering the question of how the property you intend to purchase will be used. The options include primary residence, second home, and investment property. The option you select will play a part in determining the mortgage rates you will get. They also have different requirements that need to be met before the mortgage can be approved.

Primary residences typically get the lowest interest rates among the three options. This is because lenders generally believe that a buyer will be more inclined to repay a mortgage for the house that they live in. The fact that it is the roof over your head is extra motivation to keep up with payments. It is also due to this reason that mortgages for primary residences come with the lowest value for down payments and are the easiest to get.

The boxes that a property must check for it to be considered a primary residence are:

  • You have to live in the home for most of the year.
  • The home must be within reasonable proximity to your workplace.
  • You have to start living in the house within a 60-day period after closing the mortgage. 

Buyers should also note that refinancing a primary home mortgage requires proof of residency.

Buying A Second Home That Will Be Your Primary Residence

One very important thing to note is that a property cannot be listed as your primary residence and your second home at the same time. The criteria differ for each category. A second home is typically defined as a home you would live in for some part of the year. Unlike a primary residence, you do not have to live there for most of the year, and it doesn't have to be close to where you work. Vacation homes are perfect examples of second homes. They fit the category of being a place you only live in for some part of the year, and they also do not count as investment properties.

There are a few types of loans that can't be used to buy a second home. For example, you can't use an FHA loan or a VA loan to purchase a second home. There are also some financial considerations that come into play when you are being evaluated for a second home mortgage. A notable example of this is that most lenders are stricter with the debt-to-income ratio of the buyer as well as their credit score. Affordability, location, and maintenance are three crucial things to consider when you're looking to buy a second home.

Buying A Second Home to Rent

Buying a second home that will be used as a rental property comes with a number of advantages, most notable of which are the tax deductions. But on the flip side, it also means that a buyer will become a landlord and have certain responsibilities that will require time and energy. It is one thing having a second home that you only visit for yearly vacations, and it is an entirely different thing to have a second home that will be rented out. 

As far as tax deductions are concerned, there are two conditions under which a property will be considered a second home. They are: 

  1. You must live within the property for at least 14 days per year. 
  2. You must reside in the house for at least 10 percent of the days that it is rented out. 

An example of these conditions being met is a second home that you rent out for 200 days in a year and live in for at least 20 days in the year. Meeting these conditions ensures that the house qualifies for a second home mortgage. 

Considering that second home mortgages are usually easier to qualify for than investment property mortgages and come with lower interest, it is important for you to carefully evaluate all the criteria involved in meeting them. 

100% Free - FHA Lenders - No Credit Check or SSN required
Get Free Quote

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.

Frequently Asked Questions

No, a second home cannot be considered a primary residence. This is because both home types have opposing criteria.

A second home generally means a place you only reside in for a small part of the year.

A vacation home is categorized as a second home, so the mortgage interest rates will be those of a second home mortgage.

Depending on what you would like to use it for, buying a second house can be a very smart decision. 

Yes, the interest rates for investment property are usually higher than those for a primary residence or a second home.

Like what you're reading? Subscribe to our top stories.

No spam. We take your privacy seriously.

Follow us on Twitter and Facebook.