When you buy a house, your intention for the property will affect the type of loan you get and the interest rate that comes with it. Lenders classify properties as one of three potential types: primary residence, second home, or investment property. Each property type has its own unique loan requirements, interest rates, and tax implications, and knowing the difference can help you to avoid costly legal complications.
Here’s what you can expect when buying a home with the intention of using it to generate income:
Investment Property or Second Home?
If you’re buying a home that you don’t intend to live in, you will either need to classify it as a second home or an investment property. The two are not interchangeable, and you will have to tell your lender your intentions to the property prior to getting approved for the loan.
To be clear, an investment property is a property that you plan to use to make money. A second home is a property where you intend to live at least part of every year (think vacation home, apartment in the city, etc.).
However, an investment property can be considered a second home under certain conditions. If you want the mortgage interest rates and benefits of a second home, you can classify it as such if you do not rent the home for more than 180 days each year AND you occupy the home for at least 10% of the number of days you rent the property. For example, if you rent the home for the maximum 180 days, you would need to occupy the home for at least 18 days of the year.
It’s important to disclose your intentions for the home to your lender. Misclassifying it could put you at risk for fraud charges and legal complications, so whatever money you think you’d be saving on your loan isn’t worth the risk.
Loan Options for Investment Properties
Investment properties are the most challenging to finance. For starters, the financing guidelines can vary from lender to lender, which means you’ll need to do your homework to discover the best loan option (and interest rate) for your needs.
Investment mortgage interest rates range from 4% up to 13%, while traditional mortgages start below 4%. Portfolio loan interest rates and homestyle renovation mortgage rates tend to be the most attractive for investors, which usually range from 5-7%. Bridge loans and hard money loans tend to higher interest rates and shorter terms, and are usually relied on when permanent financing isn’t an option.
Whatever loan you choose, the mortgage rates tend to be higher because the perceived risk on an investment property is higher. People are more likely to scrap a financially-draining venture than they are their home or vacation property.
Because of the higher risk, lenders usually require a higher down payment for investment properties. The good news is that even though more money is needed upfront, this helps to offset the amount of interest you’ll end up paying because your balance is lower.
Expect to pay between 20-25% of the property’s value at closing, depending on the lender.
Just like your loan for your primary residence, your lender will look at a variety of factors when assessing loan eligibility.
For starters, the lender will want to see proof that you have enough income to cover your primary mortgage and related expenses as well as your investment loan. They may also want to see a demonstrated history of property management experience before granting the loan.
Your credit score will also be a deciding factor. Unlike your primary mortgage, a higher credit score may not be enough to grant you the best interest rate. However, a high credit score combined with experience in real estate investing and an attractive financial profile could tip the scales in your favor.
How to Get the Best Investment Property Loan Interest Rate
When you bought your primary home, you probably shopped different lenders to find the best interest rate and loan terms. Buying an investment property should be no different.
Interest rates and loan options can vary between lenders, so take time to explore your options to keep your costs low and profits high.
When buying an investment property, rely on the expertise of a local real estate agent. Clever Partner Agents are top-rated in their markets and can use their industry experience to help you explore financing options for investment properties and even uncover cost savings, like a home buyer rebate.
Connect with a Partner Agent today to make buying an investment property a profitable experience.