Vacation home, second home, investment property – many people use these terms interchangeably. However, there is an important distinction between them, especially to mortgage lenders. A second home, also sometimes referred to as a vacation home, is financed differently than an investment home.
If you’re thinking about purchasing a vacation home or an investment home, understanding how mortgage lenders define the terms will be critical to taking your next steps.
What Is a Second Home?
A second home is, in short, one you plan to live in, even if only part-time. If you plan to take out a loan for a second home, you should be prepared for your mortgage lender’s definition and expectations.
Generally, mortgage lenders define a second home as one that is intended only for the use of the buyer and the buyer’s family. Most mortgage lenders have specific criteria to distinguish a second home from an investment home. According to luxurymortgage.com, some common stipulations for a second-home mortgage loan include:
- The buyer must live in the home for a certain amount of time every year.
- The home cannot be rented out.
- The location should make sense as a vacation destination and/or be a minimum distance away from the primary home.
What Is an Investment Property?
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An investment property is one you purchase for the purpose of generating a profit – generally through rental income – even if you plan to occasionally reside in the home. If you’ll need to finance your purchase with an investment home loan, pay close attention to tax rules pertaining to rentals. Even though a mortgage lender may define your purchase as an investment home, the IRS may define it differently. Kiplinger offers a succinct summary of the IRS distinctions between an investment property and a vacation home, including details about how long an owner needs to reside in the home each year for it to be considered a personal residence.
Which One Is Right for You?
Short answer: it depends. If you’re planning to finance a vacation home for personal use rather than rental income, and you’re not prepared to pay a hefty down payment, then a second-home mortgage loan could be much less difficult – and less expensive – to obtain. But if your goal is to live in the property for part of the year and rent it out the rest of the year, then you may want to consider financing a home with an investment home mortgage loan.
Second home mortgage loans may have lower interest rates, lower credit score requirements and lower down payments than investment home loans. The downside is that, under the terms of many mortgage loans, second homes often can’t be rented out.
According to mortgageloan.com, lenders generally consider investment property loans to be riskier than second-home loans, because a buyer with no intention of living in the property may be more likely to walk away from the home and default on their mortgage payments in the event of serious financial setback. As a result, lenders usually prefer higher credit scores, charge higher interest rates and require larger down payments (often 25 percent or more). Even with these conditions, the process of qualifying can involve a much more rigorous investigation into your financial health and history.
For those who are not deterred by a few extra obstacles, there are plenty of attractive financial incentives to owning an investment home.
If your dream is to own a second home to use as a family vacation destination, and you can afford to maintain a second mortgage without generating income from renting the property, then a second home could be the right option for you. You may get a better interest rate, and it’ll likely be easier to qualify.
However, if you can afford to make a larger down payment, easily demonstrate a solid history of financial stability and tolerate a higher interest rate, then an investment property could offer several financial advantages in the long run. Whichever you decide, be sure to consult your own tax, legal, financial, and accounting advisors before making any offers.
A 25-year real estate veteran, Phil Karp is head of Brokerage Services at Owners.com, an online resource which provides an easy and affordable way to buy or sell a home. Phil prides himself in helping investors understand the mortgage and tax implications of investment and vacation homes. He lives in Atlanta and shares his downtime with his wife and their rescue dog, Dakota.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of Owners.com, Altisource or any other Altisource® business or entity. The foregoing content is not intended to constitute, and in fact does not constitute, financial, investment, tax or legal advice by the author, Owners.com, Altisource or any other business or entity.