While they share similarities, there are clear differences between buying a second home and purchasing an investment property.
A second home is simply an additional property that you can use as needed; either for enjoyment, family purposes, or professional reasons. It’s a home that you occupy for less than 50% of the year, and the term can encompass vacation properties, although not all second homes are used for vacationing.
Investment properties, however, are strictly for generating income, either in the short term or decades in the future. They can include rental properties, fix-and-flip properties, or purchase-and-hold properties. If the purpose of the purchase is to make money, and it will not be used for person reasons (at least primarily) it’s considered an investment property.
How are The Purchases Similar?
There are fine details, but overall the loans for these two types of properties are similar when compared to typical home loans. Compared to a mortgage on a primary house, these properties have higher qualification standards and more requirements. This can include potentially higher downpayments and interest rates.
But there are differences between the two. When compared to each other, you’ll see specific differences.
The Differences Between Buying a Second Home and an Investment Property
Downpayment
Both of these properties have relatively high downpayment requirements, but because investment properties have slightly higher risk (because loan repayment usually depends on rent checks), the downpayment for investments is slightly higher.
Much will depend on the lender and the property, but it’s possible for lenders to require as much as 25% down on the property. When buying a second home, you can find options as low as 5%. (These are the extremes, and there can be much overlap.)
The difference between 25% and 5% is massive. For a $400,000 property, which is certainly moderate in many areas, a 25% downpayment represents $100,000. A 5% downpayment is only $20,000.
Again, there is overlap, but this example demonstrates the large differences in downpayment requirements.
Mortgage Interest Rates
For both of these properties, you can expect interest rates to be slightly higher than typical home loans.
In this case, there is usually little difference between the two. You have likely read about record-low interest rates, and while rates for these properties have dropped, they are not as low as the significantly low rates for primary homes.
So while both are slightly higher on interest, you likely won’t find a major difference between the two.
Qualifying Income
This is one aspect of the loan that is significantly different. Loans for both of these properties can use regular income, retirement accounts, and other typical income forms to qualify for the financing.
But because an investment property is intended to bring income to your bank account, it’s possible to use future rent as income on the application. Obviously this is not an option when buying a second home, as they don’t bring an income and repayment depends specifically on your current salary, wages, investment payments, and other traditional money sources.
To use future rent as qualifying income towards your loan, you simply need to go through a market assessment with the property. This will be completed by a qualified professional. Once complete, you should have a number that can apply to your income for purposes of reaching loan approval.
It should be noted that this is an option only for rental property; fix-and-flip loans and other types of investment purchases may not be able to use this feature.
Distance from Primary Residence
Regardless of whether you use a loan or not, there will likely be restriction on the location of your second home, restrictions that do not apply to investments.
To qualify when buying a second home, the new property will likely need to be at least 50 miles from your current residence. This can increase to 100 miles depending on the lender and the property.
Essentially, this is a requirement that ensures the property is, in fact, a second home and not an investment. The logic being that most people don’t need second homes close to their current residence.
But this is not a hard rule, and not all lenders enforce this type of restriction. If the second home is close to your primary residence, but could be considered a vacation property (near a lake or ski resort, for example) you may be able to bypass this requirement.
Cash Reserves
This is simply cash that you have on hand, money that can be used to pay the mortgage if a financial emergency occurs. Once again, we see higher cash-reserve requirements for investment properties compared to second homes.
For a second home, you may need about two months of cash reserves, which is a fairly reasonable requirement, one that most people can meet. For an investment property, however, you may need as much as a year in mortgage-payment savings. So if the mortgage payment is, say $3,000, for a second home you would need about $6,000 in savings.
For an investment, however, you may need as much as $36,000 in savings. Once again, we see that the upfront costs of buying an investment property can be higher than buying a second home.
Overall Conclusions: Investment Loans Require More
You can likely see the trend. Overall, loans for investment purchases will usually require more because of the slightly higher risk. Be prepared when you start to look at investment loans and don’t be shocked if your lender requests thousands of dollars in downpayments. You may find higher interest rates, and the cash-reserve could be larger as well.
Get a Second Opinion on Your Investment-Loan Application
Remember, you can always get a second opinion. If you feel an investment-loan offer does not meet your specific requirements, we encourage you to contact our staff. It never hurts to see if a different loan agent can provide better terms on your loan for a second home or an investment property.
Whether you are buying a second home or purchasing your first investment property, we would love to help! Please contact us today and find out how our common-sense approach can increase your chances of loan approval!
