If you’ve ever considered buying a second home, it’s important to understand the mortgage rules are a bit different from that of your primary residence. There are also key differences between buying a second home and an investment property, and you should be aware of these distinctions because often the two terms are used interchangeably.
The Meaning of “Second Home”
The term second home refers to a property that you will live in for part of the year, in addition to your primary residence. It’s usually a vacation home, but a second home might also be somewhere you go for work. For example, maybe you have a condo in a city where you often work, but it’s not your main home.
If you’re going to get a mortgage for a second home, it will usually need to either be in an area known as a vacation or resort location, or it might need to be a specific distance from your primary residence.
A second home loan will often have a lower interest rate than an investment property loan.
Your loan will probably also have what’s called a Second Home Rider.
The rider says that as the borrower, you’ll occupy the property and use it as your second home. The property can’t be part of a rental pool or timeshare agreement, and there can’t be agreements requiring you to rent the property or give a management company or third-party control over the property’s use.
While the above is the general definition a lender might use, every lender is going to have their own specific requirements that might be different from these.
Some lenders, for example, won’t give you a second home loan if you’re going to rent out your home at all. Others will give you a loan as long as you plan to stay in the home for a certain number of days annually, even if you’re also going to rent it out.
What About Financing an Investment Property?
One of the reasons it’s important to understand the differences between a second home and an investment property is because the financing process is different. It tends to be significantly easier to finance a second home compared to an investment property.
Usually, a second home mortgage is going to have an interest rate that’s fairly comparable to those for buying a primary home, and credit requirements tend to be in line with one another too.
It’s harder to qualify for an investment property mortgage, and the interest rate is probably going to be higher, as are the origination fees.
That doesn’t mean an investment property mortgage isn’t without its own benefits.
With an investment property, some lenders are willing to give you a loan more easily because the idea is that the property will generate the cash flow needed to pay your loan and other expenses.
What About the IRS?
The IRS has its own guidance as far as the comparison between a second home and an investment property.
A property can be a second home if you use it for at least 14 days each year, or 10% of the days you rent it. If you don’t meet that standard, it’s an investment property.
Why does it matter?
If you have a second home, you may qualify for a mortgage interest tax deduction. That can be used on interest paid on up to $750,000 in qualifying residential debt.
If you have an investment property, you can use the deduction the same way, but you can deduct interest on your mortgage as a rental income expense.
As an owner of an investment property, you can claim an annual depreciation expense, which would lower the amount of your rental income that was taxable.
No matter how the home is specifically classified by the IRS, if you use it and rent it, you have to divide expenses by the time it’s rented and the time you use it personally.
Finally, if you’re thinking about fudging the truth a bit, that’s not a good idea. You will have to sign off on what your intended use of the property is going to be, and if you aren’t honest, it can be considered mortgage fraud, which is illegal.