The Differences Between Buying a Second Home vs. Investment Property

As a property owner, there are many types of homes and properties with nearly endless potential to expand and diversify your portfolio. When buying a home that will not be your primary residence, it's essential to understand whether a second home or an investment property will be more in line with your goals. Read on for expert advice from the trusted Realtors at Pacific Edge Real Estate if you’re seeking a second home or investment property that will benefit you in the long run.

A second home is a property purchased in addition to a primary residence for your personal use, vacations, or enjoyment. A second home is inhabited for at least part of the year. You may use it for holidays or leisure, as a pied-à-terre, or as a secondary work location. According to the IRS, a second home is a property you live in for more than 14 days per year (or more than 10% of the total days you rent it to others).

A second home is a wise investment if you regularly travel to a specific area for vacations or other purposes. Instead of spending money on hotels or rental homes during this time, you have the freedom and comfort of staying on your own property. It’s the perfect way to create your own piece of paradise in a second location.

Investment properties differ from second homes in that their intended use is explicitly for generating income rather than being used as a personal residence. You might purchase an investment property to flip and sell for a profit or to use as a rental. Rental properties can also be multiunit, which allows the property owner to earn income from multiple tenants simultaneously, bringing in further revenue. Units with businesses as tenants rank as commercial properties.

You can build and diversify your investment portfolio with different types of investment properties, allowing you to grow equity in real estate through multiple channels.

There are some similarities in financing a second home compared to an investment property, but their processes and requirements differ from the funding of a primary residence.

Qualifying for a mortgage for a second home or an investment property will likely require extra work and attention to detail, especially if you still have a mortgage on your primary residence. Banks need to know that you have healthy cash reserves, so they'll study your financial situation more closely to ensure you are eligible. Mortgage lenders will require a specific down payment, credit score, and debt-to-income ratio, and your interest rate will be higher than that of your primary residence. Typically, receiving a second home mortgage or a loan for an investment property will require a credit score of 680 or above with a debt-to-income ratio of no more than 45%.

Lenders will vary on this requirement, but you may need to produce a more considerable down payment for second homes or investment properties. Depending on your situation, this could range from 15% to 25% down. The higher the down payment you can manage, the better your interest rates will be.

When buying an investment property, a lender may allow you to demonstrate your willingness to use anticipated rental income to cover your mortgage payments. However, this can be complicated because you must prove how much rental income you expect the property to generate. This may involve a specialized appraisal.

When taking out a mortgage on a second home or an investment property, you should expect a higher interest rate for either one because occupancy is a major factor when setting mortgage rates. Lenders see these as riskier transactions. If a borrower gets into a pinch with money, they are more likely to stop paying a mortgage on a second home or investment property than they are on their primary residence.

A second or vacation home will see only slightly higher rates than a primary residence, while an investment property may be anywhere from 0.5% to 0.875% higher than market rates. Borrowers with a low credit score and a low down payment may see an even higher rate if they qualify.

Although it may be tempting to classify an investment property as a second home to avoid the higher interest rate and down payment requirements, this can lead to severe consequences. Transparency is imperative, and lying to your lender about the property's intended use, or committing occupancy fraud, could lead to significant fines and even federal investigation. Most lenders will require disclosure of intent through an occupancy affidavit. If you intentionally misrepresent the use of the property, they will have the right to foreclose on the loan. Additionally, many mortgage companies use various methods to confirm who lives in the home or will search for evidence of mortgage fraud.

If you already own a second home and are considering turning it into an investment property, you and your lawyer should read your mortgage terms carefully. Verifying any restrictions allows you to avoid unintentionally committing occupancy fraud. You will also have to report rental income to the IRS. While refinancing is an option, you must consider all investment property guidelines.

When it is time to purchase your next piece of property, partner up with an experienced professional who understands the finer details of real estate investments. The acclaimed team at Pacific Edge Real Estate can offer top-tier advice as you seek a second home or the perfect investment property to add to your portfolio. Reach out today to discuss your goals.