Bankruptcy

The Difference Between an Investment Property and a Second Home

By Amy Loftsgordon, Attorney
Whether a residence is classified as a second home or an investment property matters when it comes to mortgage loans.

People commonly use the terms “second home and investment property interchangeably, referring to property that isn’t a primary residence. But the concepts really are different: A second home is a property someone lives in for part of the year (like a vacation home), while an investment property is used to generate income (like a rental house).

Mortgage lenders generally offer borrowers better loan terms on second home loans than on investment property loans. The difference in terms—primarily a lower interest rate—might tempt someone who plans on using a property as a rental to call the place a second home when taking out the loan.

But that’s a bad idea. Purposely taking out the wrong type of loan to get a better deal is mortgage fraud. Also, even if you truthfully state on a loan application that you plan to use a property as a second home, but later decided to rent it out, you could face a foreclosure for violating the mortgage terms.

Second Homes: For Vacations

A second home is a residential property that an owner occupies for part of the year. Often, a second home is a vacation home, like a cabin on a lake, a beach house, or a mountain cottage. A second home could also be a residence, like a condo, that a borrower stays at once in a while when conducting business in a faraway city.

To qualify for a second home loan, the property and borrower must normally meet certain eligibility requirements such as:

  • The home must be in a resort or vacation area or a certain distance—usually 50 or more miles—from the borrower's primary residence.
  • The borrower has to occupy the home for part of the year.
  • The home can’t have more than one unit.
  • The property must be usable year round.
  • The home can’t be part of a rental agreement that requires the borrower to rent the property or part of a timeshare arrangement.
  • The borrower must control who uses and stays at the property, and can’t give a management firm control over who lives in or uses the property.

Though second home loans usually have lower interest rates than investment property loans, the actual rate that a borrower gets will depend on factors like the borrower’s credit history, income, and assets. among other factors.

Lenders also typically allow a borrower to make a lower down payment on a second home loan. For a second home loan, most lenders require a down payment of around 10% to 20% of the property’s purchase price. For investment property loans, they usually require around 25%.

Investment Properties: To Make Money

An investment property is a residence someone buys to make a profit and doesn't live in for any amount of time. Unlike a second home, an investment property can be—and often is—near the borrower’s primary residence. A single-family home in the borrower’s hometown rented to tenants is an example of an investment property.

Investment property loans are risky for lenders. Borrowers are more likely to walk away from rental properties—and the related mortgage payments—when facing a financial crisis, like unemployment or unexpected medical bills. Second home loans are less risky for lenders because a borrower actually lives in the property, even if only part time.

Investment property loans have higher interest rates to compensate for the higher risk. Lenders also ask for larger down payments because borrowers who have significant equity in a property are less likely to skip out on a mortgage.

Consequences of Getting the Wrong Type of Loan

Again, if you try to skirt the rules and apply for a second home loan even though you really plan to use a property for investment purposes, you’ve committed mortgage fraud. The potential penalties for mortgage fraud include fines and restitution to the lender.

Taking out a second home loan with the idea of using the residence as a vacation home, then later renting it out likely violates the mortgage terms. A lender who finds out you’re violating the mortgage terms by renting out what you labeled as a second home might accelerate (call due) the entire loan amount. If you can’t work something out with the lender, you’ll have to repay the loan or the lender will foreclose.

Getting Help

If you need help figuring out whether you should get a second home loan or investment property loan, consider talking to a real estate attorney before filling out a loan application.

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