You’re interested in buying a second property and maybe spending vacations there, or perhaps turning it into a rental. Does it matter what your intentions are when you are closing the sale?
The short answer is yes. Getting a mortgage for a second home vs. an investment property may seem like it should be the same process. But there are very different definitions and rules distinguishing them – both when financing the property and filing your taxes once you own the home.
Find out how these two purchases differ in terms of mortgage requirements, loan terms and tax implications.
Definitions Of Second Home And Investment Property
Defining what type of property your non-residential purchase is has an impact on both your mortgage and your future taxes.
Definition Of A Second Home
A second home is a property purchased for personal use in addition to your primary residence. For taxation purposes, the IRS requires that this property must be owner occupied for at least part of the year. Occasional rentals are allowed, but it can’t be rented out full time.
According to the IRS, residence rules apply if you stay there for more than 14 days per year or for more than 10% of the total days you rent it out (whichever is greater). Here’s what that looks like in practice.
Let’s say you rent out the property for 200 days per year. If you stay at the property for 15 days, it is still considered your residence (versus a rental property). Definition Of An Investment Property
An investment property is primarily used to generate income. While you can stay there for a limited number of days each year, the main purpose is to either rent it out or resell it for a profit.
In order to claim tax deductions on the property, you can’t exceed the personal-use days described above. Otherwise, you run the risk of having the property reclassified as a second home instead of the investment property you intended it to be. And that can have a major impact on your taxes.
Compare Mortgage Offers From Verified Lenders:
How To Get A Mortgage: Key Differences
Both the IRS and lenders have different rules for investment properties, which is why it’s so important to make sure you correctly classify any homes beyond your primary residence. Here’s how the mortgage process works for each one.
Buying A Second Home With A Mortgage
Buying a second home with a mortgage has different requirements than when you purchased your primary residence. While every lender will have their own set of eligibility criteria, here are some basic guidelines you’ll likely find:
- The borrower must occupy the property for at least part of the year.
- The property must be available for personal use for at least half of the year.
- Short-term rentals are allowed.
- The second home must be able to handle year-round occupancy.
Some lenders also require a second home to be at least 50 miles away from your primary residence. Expect to pay a down payment of at least 10%; if the mortgage is a jumbo loan, you’ll likely need a 20% down payment. You’re also limited to conventional loans because FHA and VA loans can be used only for primary home purchases.
In addition to a 10% to 20% down payment (depending on the loan type), you may also have a higher interest rate than you would with a primary residence mortgage. That’s because lenders perceive a higher risk with a second home than with your main home. Cash reserves may also be required, but that varies by lender.
Buying An Investment Property With A Mortgage
Lenders tend to have stricter mortgage requirements for an investment property than they do for a second home. A down payment requirement on an investment property ranges from 15% (at least) for a conventional mortgage to 10% to 30% for hard money loans.
You’ll also pay more in interest since there’s less personal attachment to the property. Expect your rate to be 1% – 3% higher than the rate for a personal mortgage.
Cash reserves are another lender requirement, which means you must have enough money on hand to cover between 2 – 6 months of mortgage payments.
One less-stringent requirement when buying an investment property instead of a second home is location: There’s usually no minimum distance required from the rental property to your primary residence.
| Mortgage Requirements | Second Home | Investment Property |
|---|---|---|
| Down Payment Minimum | 10% for conventional loan 20% for jumbo loan | 15% – 30% |
| Minimum Credit Score | 640+ | 680+ |
| Cash Reserves | May not be required | 2 – 6 months of housing costs |
What’s Your Goal?
Buy A Home
Discover mortgage options that fit your unique financial needs.
Refinance
Refinance your mortgage to have more money for what matters.
Tap Into Equity
Use your home’s equity and unlock cash to achieve your goals.
Other Financial Considerations
What are some other financial key differences when deciding between a second home and an investment property? Take a closer look at taxation and property insurance requirements.
Taxation
Both the taxes you pay and the deductions you can take vary based on property type.
Second home: There are some potential tax deductions you may qualify for after buying a second home. Property taxes and mortgage interest can be taken as itemized deductions, up to the allowable limits each year. The catch? The maximum deductions apply to all of your personal properties, so if you already use all of your deductions on your primary home, you can’t take any additional deductions for your second home.
What happens when you’re ready to sell your second home? You’ll most likely have to pay capital gains tax on the appreciation. Primary residences come with an exclusion of $250,000 – $500,000 (depending on your filing status), but that tax perk doesn’t apply here. The exception is if you spend over half of the year in your second home for at least 2 of the last 5 years before you sell it.
Investment property: Rental income must be reported on your tax return, but you can take a number of deductions to help lower your final tax bill. Eligible deductions include:
- Mortgage interest
- Property taxes
- Operating expenses
- Depreciation
- Repairs
Like a second home, selling an investment property can trigger capital gains tax on the property’s appreciation above the original purchase price. However, if you’re replacing one investment property with another, you may be able to defer capital gains tax through a 1031 exchange. There are many rules you must follow in order to qualify, but you can avoid paying taxes if you sell one property and then buy a similar property.
Property Insurance
While homeowners insurance is required for your primary residence, you’ll need an additional policy when buying a second home or an investment property.
Second home: Your insurance for a second home is based on the property details, so you could see a very different premium than you have for your primary residence. Location is a major factor: If your vacation home is near the water or in a hurricane-prone area, you may see a higher premium. However, you may be able to extend the liability coverage portion of your primary residence policy to your second home policy.
Investment property: When you invest in a rental property, you’ll need a landlord policy instead of a homeowners policy. That covers the building itself, but not personal property or extensive liability at the building. Those should be covered by your tenants’ rental insurance policy.
Ready To Become A Homeowner?
Get matched with a lender that can help you find the right mortgage.
FAQ
The Bottom Line: Make Your Plan Before Applying For A Mortgage On A Second Home Or An Investment Property
The mortgage process is different depending on whether you’re buying a second home or an investment property. Being well prepared is the best way to successfully navigate the application process and improve your chances of expanding your real estate portfolio, whether it’s for personal enjoyment or ongoing rental income.
Want to learn more about different types of mortgages for your next purchase? Explore home loans now.
Lauren Ward
Lauren Ward is a writer with over a decade of experience covering financial topics for businesses and publications. Her work has also been featured in major publications such as U.S. News and World Report, CNN, Business Insider, The New York Post and Bankrate. Her expertise includes real estate, mortgages, small business, insurance and more.
