When taking out a mortgage loan, there are several different categories that the loan falls under, depending on what you intend to do with the home understanding the mortgage process will help you navigate the purchase of your second home or investment property easier. For a home that you intend to live in as your primary residence, this would be a primary home. For a home that you intend to live in for a portion of the year, but not the majority of the time, this would be a second home. And for a home that you do not intend to live in at all, but use to generate income, this would classify as an investment property. These distinctions are important, and we are going to go into detail on the key differences between second homes vs. investment properties, and what they mean for you.
Buying Second Homes
The most popular reason you may purchase a second home is for a vacation property. While you may think the home has to be in a destination, it does not. You can purchase a property anywhere in the united states to be used as a second home. The most popular places for second homes are lakes, beaches, ranches, or anywhere else you may like to kick back and relax.
Purchasing a second home may seem out of reach, but the option of a mortgage makes it much more attainable. Some may assume you need to bring a 20% down payment to the closing table to qualify for a mortgage on a second home, but in some cases, you can put as little as 10% down. Having a lower required down payment makes buying a second home feasible for someone who may not have a lot of liquid funds they can use. When you put less than 20% down, there will be Private Mortgage Insurance (PMI), which is paid until the Loan-To-Value (the amount you own vs the value of the home) is at or below 80%. You can either pay PMI monthly or upfront. Paying upfront will help keep your monthly payment more affordable. There are also some requirements that you and the property must meet to be considered a second home: you must currently own a primary residence, you must occupy the second home for some portion of the year, the property must be available for your personal use more than half of the calendar year, and the home must be suitable to live in year round.
There are options to purchase a second home and rent it out for portions of the year. This may be beneficial to you if you want to buy a second home in a vacation area and recoup some of your cost by renting it out when you are not enjoying the property yourself. When deciding to do a second home vs. investment property, there are a few requirements that must be met to keep the property from being classified as an investment, which has stricter guidelines to adhere to. You must occupy the home for some portion of the year, as well as have exclusive control of the property; the property can only be a single unit home, and you may not use any rental income to qualify for the loan.
Buying Investment Properties
Investment properties give you more freedom on what the property can be used for, but with stricter guidelines and requirements in place to qualify than when purchasing a Second Home. The most common reason you may purchase an investment property is to use it as a rental. If you purchase a property with the primary use being to produce income or turn a profit, and you do not live in the home, it will be classified as an investment property.
When you purchase an investment property, the main goal is to produce income on one investment property or multiple homes. While most think of income as a monthly stream of money coming in, it can also be buying a home and flipping it for a profit. Investment properties do not have to be a typical single-unit house, they can be 1-4-unit properties. As with second homes, you do not have to put 20% down, but you will have a higher rate and will have PMI as well. Though you will have a higher rate, there may still be a time where purchasing an investment property makes sense, even if you don’t have a full 20% to use as a down payment. Another factor to consider when financing an investment property is reserves. Reserves are a specified amount (typically a set number of months of your principal, interest, taxes, and insurance payment on the loan) of cash on hand required on top of funds needed for closing. This may be another reason why putting 20% down is not attainable for everyone.
Another benefit of an investment property is the ability to use the anticipated income for the property as part of your qualifying income for the loan. This could be a great way to help qualify for the mortgage loan. However, using anticipated income will require additional documentation, including, but not limited to: a history of managing investment properties, a specific appraisal that includes an income-based approach, and possibly the lease for the property.
Leveraging the low rates, you see today, could make it the perfect time to purchase an investment property or second home. Second homes vs. investment properties; which one makes the most sense for you? Whether you are looking to purchase your dream beach bungalow, a cabin in the mountains, or your first rental property, there is no better time than now to discuss your options. Reach out to a Mortgage Banker today, to see what you may qualify for. Your dream might be much closer to becoming a reality than you might have thought.