You own your primary residence, but you’re thinking about buying a second home or possibly an investment property. Congrats! Being in a financial position to make that kind of real estate investment is a major accomplishment, and you should be proud of that.
There are a few key differences between a second home and an investment property. They can impact your interest rate, down payment, ability to qualify, and even taxes. Make sure you’re clear on the goals for your new property from the outset.
You can also turn to APM or a trusted real estate agent for additional information on these non-primary residences.
Interest Rate Differences
There is a noticeable difference between the mortgage rates on second homes vs. investment properties. Second home loan rates are more like those of primary residences, while an investment property will typically have higher interest rates. Rates on investment properties can be 1 to 3 percentage points higher, depending on credit and loan-to-value ratio.
Why is there such a difference? Because borrowers don’t live in investment properties, they’ll prioritize paying for their primary home if money gets tight. Plus, many rely on rental income to cover the loan, so if the property sits vacant, payments may be missed. These factors make investment properties riskier than primary residences.
Remember that for both second homes and investment homes, your mortgage rate is also influenced by both credit and down payment.
Down Payment Requirements
A typical down payment on a second home is 20%. However, you can find options to put as little as 10% down, depending on your credit score and other qualifiers. Investments like rental properties, on the other hand, tend to require 20% to 25% down.
This doesn’t mean you can’t find other options, but you’ll need to discuss your entire financial picture with your Loan Advisor to get more details on available programs.
The Need for Reserves
Reserves are the savings balances that you’ll have after you close on your home purchase. These are seen as emergency funds that assure lenders that you will be able to continue making payments should any unforeseen expenses or income loss come your way.
Some lenders require reserves on second homes, and they almost always require them on a real estate investment like a rental property. These reserve requirements can range from two to six months of your total housing payments. Your Loan Advisor can go over the details of your transaction to ensure you have the reserves you need after the down payment.
Debt-to-Income Ratio Calculation
Since this new home will be in addition to your primary residence, you’ll have to include the mortgage payment on your primary home, plus the new mortgage payment, into your debt-to-income (DTI) qualifying ratio.
Though you may be able to rent out your second home on a short-term basis, you cannot count that anticipated income in your DTI calculation.
If your home is an investment property, however, lenders will generally allow you to include the estimated rental income to help qualify. This is called a DSCR loan (debt service coverage ratio).
Proximity to Primary Residence
For your new home to qualify as a second home, lenders will generally require that it be located at least 50 miles from your primary residence. An investment borrower, on the other hand, can live as close or as far from their rental properties as they like.
Regardless of their proximity to their real estate investment, these landlords should have a property management plan in place to maintain the day-to-day operations and maintenance required for an investment property.
Credit Score Requirements
As you would expect, a higher credit score is always favorable for any home purchase. A borrower purchasing a second home typically needs a credit score of at least 640. This can also hold true for investment buyers, although many lenders require a score above 680.
Tax Benefits and Considerations
Rental income is taxed differently depending on whether you have a second home vs. an investment property.
If you own an investment property, the generated rental income must be declared as part of your taxable income. Those who own a vacation home are exempt from this requirement as long as their property is rented out for 14 days or fewer per year.
Investment homeowners do get a few tax benefits, though. They are able to deduct depreciation, in addition to property maintenance, advertising, insurance, and utility expenses. As you might guess, these deductions can go a long way toward offsetting the overall tax impact of the asset’s rental income.
If you’re using the property as a second home, you can deduct mortgage interest (up to $750,000 in mortgage debt), property taxes, and mortgage insurance payments.
Both investment properties and second homes are subject to capital gains upon selling.
Discuss Your Real Estate Investment with a Pro
The key takeaway from this article is that the discussion over whether to purchase a second home vs. an investment property boils down to your short and long-term goals.
Here are some additional blogs from APM with resources to help you navigate this process:
Here’s something else you need to know: You don’t have to make these decisions alone. Reach out to a Loan Advisor at APM—we are here to assist you in this process.