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Buying a second home can open up a whole new world of possibilities, but those possibilities may be limited depending on how that home is categorized by your mortgage lender. Knowing the key factors lenders use to differentiate between a second home vs. an investment property – and knowing what your mortgage terms and requirements might be based on – are essential to deciding how you’ll use your property.
Second home vs. investment property: What’s the difference?
The way mortgage lenders classify second homes and investment properties varies from lender to lender, but here are a few rules of thumb:
A second home
- Must be lived in/used by the owner (you) at least 14 days of the year
- Cannot be rented out more than 180 days of the year
- Must be a minimum of 50 miles from your primary residence
An investment property
- Is occupied by you fewer than 14 days of the year
- May generate income through long-term rental, short-term rental or “flipping”
- Can be within 50 miles of your primary residence
The criteria lenders use are often based on the definitions the IRS uses to differentiate between a second home and an investment property for tax purposes, but they’re not necessarily the same as the IRS criteria. For property and rental income tax info, be sure to check with the IRS.
What do mortgages for both second homes and investment properties have in common?
Mortgages for investment properties and second homes both carry a higher risk for lenders than mortgages for principal residences because when finances are tight, lenders expect you are more likely to pay for the roof over your head than a home you’re not living in. Lenders make up for this higher risk with stricter requirements and higher interest rates.
Unlike the mortgage products you may have used for your primary residence (FHA loans, VA loans, etc.), both second home and investment property mortgages will require a down payment, plus cash reserves and good credit.
What are the key mortgage differences between a second home vs. an investment property?
Number of units: For a second home, you are only allowed a mortgage on a single-unit property, whereas with an investment property, you can mortgage a property of up to four units.
Interest rates: Even with the same amount of money down and the same loan length, a mortgage for an investment property will almost always carry a higher interest rate than a mortgage for a second home.
Down payments: Like a mortgage for a primary home, the higher your credit score, the less money you’ll need for a down payment. However, a second home will require a minimum down payment of 10%, while an investment property minimum down payment starts at 15% and can be as high as 25%, according to the Fannie Mae Eligibility Matrix.
Credit score: If your debt-to-income ratio (DTI) is less than or equal to 36%, your minimum required credit score will be the same – 640 – for both a second home mortgage and an investment property mortgage. But if it’s between 37% and 45% (the maximum allowed), you’ll need a minimum score of 660 for a second home and 680 for an investment property.
Cash reserves: A mortgage for a second home will require you to have a minimum of two months of cash reserves on hand. For an investment property, you will need a minimum of six months’ cash reserves.
Income reporting: Because an investment property has the potential to earn you additional income through rental or resale, mortgage lenders will often include potential future profits when calculating your DTI for an investment property. You won’t have that perk with a second home mortgage.
Origination fees: Lenders often charge higher origination fees (the fees charged for mortgage processing at closing) for investment properties than for second homes.
Can I start out using a home as a second home and then change my mind and use it as an investment property?
Yes, but you’ll have to notify your mortgage lender and the IRS, and you may face penalties. It’s important to be as upfront as possible about your intentions for your second home or you could face serious legal consequences. Mortgage lenders can (and will) use information from your credit report, tax records and more to ensure you’re using a property the way you agreed to in the first place. If they discover occupancy fraud, you could face serious legal consequences, including prison time.
How can I get the best rates and terms for my second home or investment property mortgage?
None of the rules laid out here are set in stone, and you’ll find that rates and terms vary from lender to lender. It’s important to shop around and talk to several lenders to find the best deal on a mortgage for your second home or investment property.
You can also put yourself in a better position for a second home mortgage by considering a co-ownership LLC like those offered by Pacaso. You’ll enjoy all the benefits of second home ownership with a lower down payment and a lower monthly cost of ownership.