Are you thinking about buying a second home? Or are you really looking for an investment property? There is a difference between the two and how you can finance each of them. It’s important to understand the distinction for both financing and tax purposes.
In real estate terminology, a second home means one thing. When you are looking for that "second home," you are looking for another home to use for yourself and your family. It's a property that you want for personal use and the focus is not as an investment. Lenders generally assume a property to be a second home if it's 50 miles or more from your primary home.
The terms and conditions for financing second homes are different than a primary residence or investment property. While not as easy to get as financing for your primary home, it's still attractive financing.
If the second property is for investment purposes, like for short-term or long-term rentals, it’s viewed differently from a financial perspective. The interest rates and terms and conditions will be based on that fact.
If you are looking for a second home for you, then expect higher down payment amounts for this type of financing. The standard down payment for a second home is 20% of the purchase price. There are a few options that allow 10% down based on your finances, but they are rare. Interest rates are also going to be higher. You can expect, on average, interest rates a quarter of a point to a half a point higher than the rate on your primary home. If you put 25% down, rather than the standard 20%, you could qualify for a lower interest rate.
Another point to consider is your credit score. Financing for a first home has options available for a range of credit scores. It's different for second homes. Many lenders for this type of financing require a credit score of 725 and above in order for you to qualify.
Financing for investment properties considers your financial situation. But the income potential for the property is also important. Your lender will review the information provided by you as well as comparable properties. Comparable properties are other rentals in the area. Your lender wants to know what rents are being obtained for your type of property.
Your lender will only count 75% of the anticipated rents as income. And the monthly mortgage, taxes, and insurance are added to your personal expenses. That means your debt-to-income ratio (DTI) will be a lot higher.
Lenders usually will ask for 15% to 25% down payment on an investment property. Credit scores for an investment property can be as low as 620 for some lenders.
The interest rate for your investment property will be higher than your primary home. The reason for this is that lenders consider these loans riskier than a primary home to finance. Because a borrower isn't living in the home, there's a higher chance they might default on the loan. The default could be because tenants stopped payments or the property suffered damages. It also could be because the borrower has financial issues like losing a job.
If you are thinking about buying a second home, talk to an experienced real estate agent. A knowledgeable realtor can explain how second home financing works. Your agent can discuss what type of financing options you have and help you understand the costs.