Suppose you buy an investment property, such as a beach house, then you use this house for a few months and rent it out for the remaining part of the year. What does that make this house? Is it your investment property or a second home? What does investment property refer to in this instance? It is vital for real estate investors and would-be vacation home buyers to know the difference between them. Here, we will focus on three primary differences between these two properties.
1. Mortgage rates
As a general thumb rule, the investment property mortgage rates would be higher than the second home rates, while everything else remains equal.
The investment property mortgage rates are 0.50-1.00% more for the loan taken for the investment property over the second home loan. Why? It is predominantly because of the higher perceived risk on investment properties. In general circumstances, people are more susceptible to ditch a business venture if it ends up being a financial hardship compared to the vacation home.
Both investment properties and second homes come with a greater interest rate than your primary home. Lenders see lesser risk when they lend money for a house that’s their primary residence, as the individuals do not bail out on making payments when they are currently living in it. In the case of a primary residence, their entire living arrangement can be put at stake.
On the other hand, in the case of investment properties or second homes, there is a greater risk for lenders, as borrowers are more prone to ditching the payments since it won’t directly affect their living arrangements.
2. Down payment
When you finance the second home, the down payment is 20%. Of course, you can find some options, wherein the down payment is only 10%, but it largely depends on your credit score, debt-to-income ratio, and other such qualification factors.
On the other hand, when you finance your investment property, meaning a home you intend to give out on rent, the down payment can be anywhere between 5-20%. However, the benefit of a higher down payment may be seen in the form of a lower interest rate, so you need to make the right decision.
Your rental income on the investment home is taxed differently from the rental income on a second home. This income should be declared in the taxable income when you have an investment property, such as Airbnb. On the other hand, the second homeowners do not have to do this unless they rented the property for more than 14 days in a year.
Furthermore, the investment property depreciation must also be deducted by investment homeowners. Along with investment property depreciation, these homeowners also need to deduct utility expenses, insurance, and advertising expenses on the taxes, among other expenses. This can help off-set the property’s rental income. Second homeowners can lower interest amounts by USD 750,000 in mortgage debt, mortgage insurance payments, and property taxes.