Second home vs Investment Property: What's the difference?
What You’ll Learn
A second home is a property you buy to use primarily as a vacation space for part of the year.
An investment property is a home you buy when you want to earn rental income, and not use the property yourself.
Mortgage requirements and tax treatments differ for second homes and investment properties, so you’ll need to decide how you plan to use the home in advance.
Pursuing a real estate investment can be an exciting venture, even if this isn’t your first time going through the paces. But if you intend to get a mortgage, you’ll need to decide exactly how you’ll use the home — as a personal vacation spot or to generate income from rentals.
Second homes and investment properties each have their own home loan and tax requirements. So, here’s what you should know if you’re trying to decide which property type may be best for your goals.
What is considered a second home?
A second home is typically thought of as a vacation home, or one you intend to use on a part-time basis. A second home must meet the following criteria to qualify for a second home loan:
- The property must be suitable for year-round occupancy, even if you only intend to use it part of the year.
- The home must be a single-unit dwelling.
- The property typically must be located at least 50 miles from your primary residence.
You must have exclusive control over the property, without any timeshare or long-term rental agreements.
- The home may not be under the control of a property management company.
What is considered an investment property?
An investment property is also known as a rental property. Rather than occupying the home yourself, an investment property should be leased to tenants to generate rental income. Here are the requirements for investment property loan eligibility:
- The property cannot be owner-occupied.
- The home can have more than one unit, with up to four units allowed.
- You can rent out the property.
- The property can be located within 50 miles of your primary residence.
- A property management company can manage the home.
Tax implications for a second home vs. investment property
When it comes to taxes, second homes are treated similarly to your main home or primary residence. You’ll typically be allowed to write off mortgage interest up to the $750,000 limit. However, if you have multiple properties, you can only deduct up to $750,000 in mortgage interest between them. The limit is not per property. Instead, it is a total deduction amount.
On the other hand, investment properties may allow for more freedom regarding eligible deductions. Owners may deduct any amount of mortgage interest, as well as certain expenses, including:
- Property taxes
- Advertising costs
- Maintenance costs and supplies
- Insurance costs
Because tax laws can be complex, it may be worthwhile to speak with a tax professional who can review the potential tax implications of either type of property. You may also wish to review tips from the IRS on rental real estate income, deductions, and recordkeeping.
What to know before buying a home as an investment
Any investment deserves thorough consideration, and real estate is no different. Before jumping in, you’ll want to look at how often you intend to use or rent the property and whether an additional mortgage fits into your budget. Both property types will also require expenses for upkeep and maintenance that should be factored into your decision.
Is buying a second home a good investment?
Buying a second home can potentially be a good investment as you may gain home equity in your purchase if the home’s value increases over time. You may also be able to rent out the property when you’re not using it. However, rentals are limited to a maximum of 180 days per year.
Keep in mind that projected rental income cannot be used to help you qualify for a second home loan. So you’ll want to confirm you’ll be eligible given your current income and financial situation.
To qualify: you'll need:
- A good-to-excellent credit score
- A down payment of at least 10%
- Enough money in liquid savings to cover the mortgage for a few months if need be.
Is buying an investment property a good investment?
An investment property may be a good match if your priority is to generate money by collecting rent from tenants. You’ll also benefit from home equity, as the property’s value increases over time or due to upgrades.
However, mortgage requirements for investment homes can be more stringent and costly than other mortgage types. These home loans also usually come with the highest interest rates, credit score requirements, and liquid asset conditions of all occupancy types. This is because investment properties tend to have higher delinquency rates than other property types — which means increased risk for mortgage lenders.
You’ll also typically need at least 10% of the purchase price for a down payment, though you may be able to use projected rental income to help you qualify for a mortgage.
Can I convert a second home into an investment property?
While converting a second home into an investment property may be tempting, there could be restrictions on doing so if you have a mortgage.
Most lenders will require you to sign a document that states how you intend to use the property. Falsifying information on that document may count as mortgage fraud, which can be punishable by fines or prison time.
Therefore, it’s best to decide how you want to use the home before applying for a mortgage.
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