A common misconception is that “vacation homes” and “real estate investments” are synonymous. However, these two concepts are completely different – apart from the fact that mortgage companies tend to increase their rates for these property types! In this article, we’ll go over everything you need to know about the two, as well as what sets them apart from better-known primary residences.
What Is a Second Home?
A second home is a residential property that you intend to use for part of the year (typically a minimum of 14 days a year). It is a property that you own apart from the property you always occupy and should be about (at least) 50 miles away from where you live. A second home is commonly called a vacation home or pieds-à-terre.
It is worth mentioning that a second home can’t be rented out to tenants, regardless of the length of stay (i.e. short-term, month-to-month, or long-term), for more than 180 days a year. Furthermore, many mortgage companies consider only one-unit properties, such as single-family homes, as second homes.
What Is an Investment Property?
An investment property, on the other hand, is a property that you purchase for the purpose of profit. It is commonly called a rental property, however, it can also include “flipped” properties that are sold for a profit. Compared to second homes that are single-unit properties, investment properties come in various property types, including single-family homes, multi-family, commercial, and more.
Real estate investors make money via rent. That’s precisely why people invest in real estate – it’s a way to generate a good return on investment (ROI) passively. Moreover, real estate investments are safer than other investments such as stocks, so if you intend to expand your investment portfolio, real estate is an excellent choice.
Pro Tip: Always consult an investment adviser if you want to purchase a rental property. Some properties are more profitable than others, so it’s best to get the advice of the pros before you buy.
What Do They Have in Common?
Vacation homes and real estate investments have one thing in common: getting a mortgage for them is more challenging. Think about it this way – if you owed the bank money, which home would you pay for first: your primary home (aka where you live) or your vacation home? You’ll probably pick the former – after all, without it, you’d probably be homeless.
Mortgage companies are well aware of this, which is why they have strict rules for anyone who wants to finance a vacation home or real estate investment. They’re aware that you’re more likely to walk away if you can’t make your payments.
What Are Their Key Differences in Terms of Mortgage?
Almost always, a rental property will cost more to finance compared to a primary or secondary residence. Below, we’ve broken down what to expect when getting a mortgage for either of these two property types:
Again, there’s no guarantee that you’ll make your payments on time. To mitigate the risk of default, mortgage companies will ask you to put down a larger downpayment for real estate investments, such as single-family rentals where the downpayment ranges from 15 to 20 percent. In comparison, the downpayment for a second home is around 10 percent, and for a main home, it’s around 6 percent.
However, this rate can reach up to 25 percent for rental properties with two or more units, such as townhomes. Fortunately, you can reduce the downpayment to as low as 3.5 percent if you want to reside in one of the units (for instance, if you reside in one unit while you rent out the other).
Don’t bother getting a mortgage if your credit score isn’t the greatest. Mortgage companies set the bar extremely high for people who want to purchase a vacation home or real estate investment. It’s not uncommon for them to set 720 as the minimum credit score. To put things in perspective, the average credit score in the U.S. is 698.
But that’s not all. They can require you to have cash on hand to cover the payments for the first year or so. They’ll also consider your income – if you can’t afford to pay for two properties (your vacation home or real estate investment, plus your primary property), they’ll be less willing to grant your mortgage.
Do note that while you may be able to use your potential rental income as “proof” that you can afford to pay for two properties, you may need to show that you have extensive property management experience.
You may be able to deduct about 75 percent of the anticipated rental income. However, do note that you may need to pay for a property appraisal based on comparable rent prices. Because of this, the cost to get a mortgage on a single-family home (that is, if you intend to claim the deduction) tends to be greater. And again, you may need to prove to the mortgage company that you have previously managed an investment property.
Should You Purchase a Second Home?
If you want to buy a vacation home, you’ll be able to benefit from a lower downpayment. Do note that if you have a vacation home, it won’t be profitable unless you rent it out as a short-term rental (within the allowed number of days, of course). As a rule of thumb, you should only get a mortgage for a vacation home if you’re absolutely sure that you can pay for it, given that you probably have a mortgage on your primary home, too.
Should You Purchase an Investment Property?
If you want passive income, real estate investments are perfect for you. If you’re a first-time rental property owner, go for one single-family home and grow your portfolio from there. Investment properties are a great way to generate a good return on investment (ROI) for a long time – even through retirement!
Start your investing journey with Luxury Property Care. Just give our experts a call and we’ll evaluate your investment goals to ensure you invest in the right property at the right time. Contact (561) 944 – 2992 or complete our contact form for more information.