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What Is a Second Home vs. an Investment Property?

Published on: March 15, 2022

second home vs investment property

When it comes to buying a second home vs. an investment property, there’s more at stake than simply semantics. How you decide to label your additional property will make a difference in how it’s treated when it comes to loans and taxes. In other words, you’ll want to make sure to classify your new home properly because it will affect how much you’ll pay to own and finance the property.

What’s the difference between a second home and an investment property?

A second home, such as a vacation home, is purchased with the intent of using it, even if only for part of the year. Generally, lenders view second homes as properties located at a significant distance from primary residences. Check with your lender for specific requirements.  

To be considered a second home for tax purposes, the IRS requires homeowners to reside in the dwelling for the greater of 14 days per year or 10% of the total time it is rented out. For instance, you’ll need to use the second home for at least 15 days if you rent it out for 150 days of the year. Meaning, even if you rent out your home for part of the year (perhaps you do so on vacation rental platforms), as long as you prove you use it primarily for personal use, it will count as your second home for tax purposes.   

The definition of an investment property, on the other hand, is a home through which your primary intention is to generate income. Even if you decide to live there, some lenders may view the home as an investment property if you’ll be generating regular income by renting part of it out. For tax purposes, an investment property is not intended to be the homeowner’s primary residence and is only used to generate income. 

Some examples of investment properties include short- and long-term rental homes, properties rented out for 180 days or more, and homes you plan on flipping.

How do mortgages differ for second homes vs. investment properties?

Typically, lenders offer less stringent qualifications and mortgage terms for second homes compared to investment properties. Mortgage rates for second homes vs. investment properties also tend to be different. Both loans, however, still typically have stricter requirements that relate to credit history, credit score, income, down payment amount, and cash reserves compared to primary residences.  

Mortgage rates for second homes vs. investment properties 

In most cases, mortgage rates for second homes are lower than those for investment properties. That’s because lenders tend to view investment properties as riskier than second homes. If a homeowner goes through financial hardship, they are more likely to forgo mortgage payments on their investment property than their second home. 

That being said, both second homes and investment properties are viewed as riskier than primary residences. So, lenders generally impose higher mortgage rates on investment properties and second homes than primary homes.  

Credit and income 

Lenders generally want to see that you’ll have enough money to cover the payments for both your primary and secondary properties. So, you may need a higher income than someone purchasing a primary residence. Plus, most lenders tend to have more stringent credit requirements for second homes. The higher your credit score, the more likely you are to qualify for a mortgage.  

The good news is that you can include anticipated rental income in your application for an investment property loan. Doing so could mean you’ll have a more favorable debt-to-income ratio — one important factor lenders review to determine whether you can afford an additional mortgage.  

Keep in mind not all lenders will allow you to do so. If they do, you may have to submit additional paperwork or go through other hurdles, such as a specialized appraisal.  

Down payments  

Purchasing a second home or an investment property requires a large down payment compared to a primary residence, although requirements for the former may be more lenient than the latter. For instance, down payment requirements for primary residences may be as low as 3.5%, such as with FHA loans, while ones for investment properties may be anywhere from 15% to 25%. 

Cash reserves and assets 

In addition to requiring more income to take out a mortgage for a second home or an investment property, many lenders may require borrowers to have cash reserves. That helps to ensure borrowers can cover mortgage payments if tenants don’t pay their rent.  

Typically, lenders may ask that you have at least six months’ worth of cash in reserve. Plus, you may be required to have more assets to prove you can draw from multiple funding sources.

Tax benefits of second homes vs. investment properties

Owners of second homes may be able to deduct their property taxes and mortgage interest as long as they meet IRS requirements for a primary home’s deductible interest. For both individuals and couples filing jointly, the maximum mortgage amount is $750,000. For married couples filing separately, the maximum is $375,000.  

Those who have purchased homes prior to Dec. 15, 2017, are grandfathered in under the previous law, with maximum amounts at $1 million for individuals and married couples and $500,000 for those married filing separately.  

For investment properties, homeowners may be able to deduct both expenses with some additional requirements. Any rental income you receive from an investment property needs to be included as part of your taxable income. For second homes, rental income is exempt as long as you rented out the property for fewer than 15 days. Owners of second homes and investment properties can deduct expenses directly related to maintaining or renting the property. These expenses can include home repairs and advertising. However, owners of second homes can’t deduct rental expenses for an amount greater than their rental income. 

Converting rental property to second homes

Some homeowners may decide to convert their rental property to a second home. Whether they want to help out a relative or simply avoid paying capital gains when the home is sold, a few steps need to be taken. This includes reporting any rental income, filing the necessary paperwork to the IRS, and updating the occupancy status. Before doing so, it’s best to speak with a tax professional to understand the potential consequences of this move.  

It’s best to contact your lender before you change your occupancy status, as doing so within a short amount of time after closing could be a red flag for occupancy fraud. Plus, it can mean that you’re at risk of breaking or defaulting on your mortgage agreement. If so, you could forfeit your home.  

It’s important to note that it’s illegal to mislead your mortgage lender about how your home is classified. If you intentionally decide to misrepresent how you intend to use the home, you could also be subject to significant fines in addition to risking your home.  

FAQs about second homes vs. investment properties

Can I rent out my house without telling my mortgage lender?

Technically, you can rent out your home. However, doing so means you could be violating the terms of your loan agreement — you’ll be committing occupancy fraud to be exact. Your lender may impose penalties, fines, and even require that you pay back the entirety of your loan immediately. If you want to rent out your home, you should inform your lender first.

Can I buy a second house and rent the first?

You can as long as you contact your lender about your intentions. The purpose is to determine whether you can handle the financial obligations of both homes. Otherwise, consider whether you’re prepared to handle being a landlord as well as juggle two mortgages.

Can I buy a second home as my primary residence?

Homeowners can only have one primary residence. For tax purposes, the IRS requires homeowners to declare one home as their primary residence. Second homes are considered part-time residences. If you plan on spending most of your time in your second home, you should contact your lender to let them know your situation has changed and consult a tax professional for guidance on reporting your residence.

If you want to learn more about your second home or investment property loan options, contact a local Finance of America Mortgage Advisor today.  

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