Comparing Second Home vs. Investment Property: What’s the Difference?

Introduction

You are already on a promising path if you have researched mortgage rates for purchasing a second home or an investment property. Either you will have a place to go for vacations or a location that will generate income and put more money in your pocket. Second houses and investment properties are not the same things at all, even though they could appear to be similar at first glance. If you are considering investing in new real estate, one of the most important initial steps is to choose the kind of home you want to purchase. Your choice of whether to buy a vacation home or an investment property may have repercussions on the interest rates and minimum down payment requirements of your mortgage, as well as on whether or not you are eligible for tax benefits.

What Is The Main Difference Between Having A Second Home And A Property Used For Investment?

Purpose

A residence purchased to use only for occasional stays, such as vacations, is known as a "second house." You may, for instance, buy a cottage to use on the weekends during the summer or a condo on a ski hill to use during the winter vacations. It doesn't matter if you opt to rent your second house when you're not using it because the Internal Revenue Service will still consider it a vacation property. After all, you use it personally. Your tax burden will be influenced by the frequency of your rentals (see below). A home purchased only for generating income and not to use as a primary residence is an investment property. You might have the intention of renting it out, selling it at a profit at some point in the future, or doing both.

Mortgage Rates

Mortgages for second homes and investment properties typically come with interest rates that are higher than the rates you could get on a mortgage for your primary residence; however, the rate you are offered will vary depending on factors such as the type of mortgage, the term of the loan, your credit history, and the ratio of your debt to your income. However, in most cases, the interest rate on a mortgage for an investment property will be greater than the interest rate on a mortgage for a second home. This is because many lenders consider investment property mortgages to be riskier than mortgages for second homes. They may feel it would be simpler to walk away from the property and default on their mortgage because they will not utilise the house.

Down Payment Requirements

Because many lenders consider investment properties riskier than second homes, they typically want you to make a larger initial deposit before approving the loan. When purchasing a home for investment purposes, you should prepare to spend anywhere from 15% to 25% of the total purchase price as a down payment. This amount may vary depending on the size of the property. However, if you are purchasing a second home, your lender might allow you to put down as little as 10% of the purchase price.

Other Qualifying Requirements

To be eligible for a mortgage on a second home while you are still making payments on your first home loan, you will need to demonstrate that you are financially capable of meeting the obligations associated with both mortgages. However, suppose you are purchasing a property to rent it out. In that case, your lender may count as part of your qualifying income up to 75 percent of the rental income you anticipate receiving from the property.

Your debt-to-income ratio (DTI) will go down as a result, making it simpler for you to get approved for a mortgage on an investment property. Your lender may impose geographical restrictions on your second home if they believe it will be used primarily as a getaway or vacation property. For example, they may require it to be situated a certain distance from your primary residence to qualify for financing. There are none of these restrictions placed on investment properties.

Tax Treatment

A second home and investment property might make filing your taxes more difficult, especially if you rent out the properties. Calculating the percentage of time spent living in your second house that was spent on personal use vs time spent renting it out is necessary to comprehend your associated tax liability. You won't be able to deduct all your rental expenses if you use the property for more than 14 days, which is the same as using it for more than 10% of the total number of days you rent it out.

On the other hand, it is possible that you can still take itemised deductions on Schedule A, such as the private part of mortgage interest and property taxes. It would help if you recorded any income from an investment property on your tax return. This is the situation in the majority of circumstances. You will be allowed to deduct rental expenses, such as maintenance, electricity, depreciation, cleaning, and even the interest on your mortgage.

Should You Buy a Second Home or an Investment Property?

Suppose you seek a location to visit on the weekends or seasonally and have enough money to support another mortgage. In that case, it is possible that purchasing a second home is the correct choice for you. You also can rent it out when you aren't using it yourself; however, if you do this, you need to be sure that you don't break the conditions of your mortgage agreement or your homeowner's insurance policy. If your place of employment is a significant distance from your primary residence and you require a place to stay during the weekdays, purchasing a second residence may be an alternative worth considering.

Conclusion

Financing for a second home purchase is often much simpler and more affordable than purchasing an investment property. Tax breaks in the form of deductions for both ownership and operation expenses can be obtained from investment properties. There are significant variations between second homes and investment properties, including the expenses that can be deducted, whether or not the property can be rented out, and even the down payment and mortgage qualification requirements. Before you get on the phone with a lender or a real estate agent, consider which of the two options would best serve your requirements.