I work with a wide variety of clients, from first time buyers to seasoned investors…and many in between. However, some of the most frequent questions I receive deal with second home mortgages versus investment property financing.
Interestingly, there are specific rules and regulations for both, and I’d like to outline a number of major differences between them.
In general, whether you’re buying a vacation home or an investment property, you’ll pay slightly higher mortgage rates and have to meet stricter guidelines to qualify.
Interest Rate Differences
Mortgage rates are generally higher for second homes and investment properties than for the home you consider your primary residence.
In general, investment property interest rates are about 0.625% to 1% higher than market rates for primary homes.
For a second home or vacation home, they’re only slightly higher (generally .125% to .25% higher) than the rate you’d qualify for on a primary residence.
Of course, investment property and second home mortgage rates depend on similar factors as those for your primary home. Each borrower’s situation will vary based on income, credit score, assets, and down payment percentage, just to name a few elements.
Why Are Second Home and Investment Interest Rates Different?
Per Miller, “The home you live in (your “primary residence”) is seen as the least risky form of real estate. It’s likely to be the one bill homeowners will pay if times get tough. A vacation home or investment property, on the other hand, is riskier. Borrowers are a lot more likely to forego those payments when money is short.
Because of the higher risk second homes pose, they come with stricter rules about financing.”
Second Home Mortgage Regulations
There are a few key things a buyer needs to know about mortgage requirements if they are considering a second or vacation home. First of all, one you will essentially live in for part of the year, but not full time.
Lenders expect a vacation or second home to be used by you, your family, and friends for at least part of the year. However, you’re generally allowed to rent the house out when you’re not using it.
If you plan to rent the property when you are not there, you cannot use expected income from that property to help income qualify for the loan.
Down Payment of 10% or More
Most lenders will want at least 10 percent down for a vacation home. If your application isn’t as strong (say you have a lower credit score or smaller cash reserves), you may have to put 20 percent or more down.
Also, gift funds are generally allowed for a portion of the down payment, but at least 5% of it must come from the borrower’s own funds if bringing in less than a 20 percent down payment
The purchase of a second home or vacation home requires higher credit scores, typically in the 640 or higher range. Lenders will look for less debt and more affordability, think of tighter debt-to-income ratios. Strong reserves (extra funds after closing) are a big help.
Investment Property Mortgage Regulations
If you are planning on purchasing an investment property there are specific rules that apply.
If you’re financing a home as an investment property, and you plan to rent it out full-time, you are not personally required to live in the building for any amount of time.
Down Payment of 15% to 25%
Down payment requirements for an investment property range from 15 percent for a one-unit property to 25 percent for a two- to four-unit property. You may also be required to make a bigger down payment depending on your application and the type of loan.
No gift funds are allowed for investment property purchases, so most lenders will require down payment funds “seasoned” for at least 60 days in the borrower’s personal account.
Using Expected Rental Income to Help Qualify
The good news about utilizing an investment property loan is that the borrower can use expected rents as income to help in qualification.
Here are some of the guidelines:
- If the property is leased, then copies of the current signed lease agreements may be required.
- If the property is not currently leased, then the lender may use “market rent” information provided by the appraiser.
- When there is no rental income for the subject property on the borrowers tax returns, the rental income will be reduced to 75% of the gross rental income provided on the lease.
You can find more on this subject here…
Lenders generally require borrowers to have a credit score above 640 for an investment property loan. With that said, rates can run very high for low credit scores.
The Bottom Line
When you apply for a mortgage, you are required declare how you intend to use the property. Lenders take such declarations seriously because they don’t want to finance riskier investment properties with residential financing.
Make sure to find a lender who truly understands the differences and requirements between second homes and investment properties. I’d be more than happy to share other resources I have on the subject, so don’t hesitate to reach out to me with your questions!