Is an investment property considered a second home?

Nikka Sulton

Is an investment property considered a second home?

Many individuals find themselves using the terms “investment property” and “second home” interchangeably when discussing real estate that isn’t their primary residence. However, it’s essential to distinguish between these two types of properties, as they serve distinct purposes and come with different financial implications.

An investment property is a real estate asset acquired primarily for income generation. This can involve renting it out to tenants or purchasing to renovate and sell for a profit. The primary goal of an investment property is to create a steady stream of revenue or to capitalize on the property’s appreciation over time. This often involves a more hands-on approach in terms of management and maintenance, as the property’s financial performance is a key consideration. Investment properties can include rental apartments, commercial spaces, or homes that are explicitly purchased for their income potential.

Conversely, a second home is a single-family dwelling that an individual acquires with the intent to use it for personal enjoyment. This property is not meant for generating income but serves as a getaway or a place for occasional residence. Many people choose to have a second home in a location they love and visit regularly, providing a sense of comfort and familiarity. Second homes can offer a retreat from the hustle and bustle of daily life, a place for vacations, or a future retirement spot. Unlike investment properties, the financial return on a second home is secondary to the lifestyle and personal benefits it provides.

What Is an Investment Property?

An “investment property” is a real estate asset with distinctive characteristics:

Non-Primary Residence: It is not your primary or main place of residence. Instead, it serves other specific purposes.
Income Generation: The primary motive behind acquiring such a property is to generate income. This can be achieved through various means, such as renting it out to tenants, profiting from its appreciation over time, or taking advantage of specific tax benefits that real estate investments offer.

Investment properties come in various forms and serve a range of financial objectives. They offer a flexible way to make your money work for you in the real estate market.

Examples of Investment Properties:

Here are some common examples of investment properties:

Residential Rental Properties: These are homes or apartment units that are owned with the intention of renting them out to tenants. The rental income provides a steady cash flow, while the property may also appreciate in value over time.
Commercial Properties: These are real estate assets used for business purposes. Examples include office buildings, retail spaces, warehouses, and industrial facilities. Investors in commercial properties aim to generate rental income from businesses and enjoy the potential for long-term capital growth.
Properties for Flipping: Some investors specialize in acquiring properties, often in need of renovation or improvement, to sell them for a profit. This strategy involves enhancing the property’s value through renovations and reselling it at a higher price.

These examples demonstrate the diversity of investment properties and the various strategies that investors employ to achieve their financial goals. Whether it’s a steady rental income, long-term appreciation, or strategic property improvement, investment properties offer a wide range of opportunities for those looking to grow their wealth in the real estate market.

What Is a Second Home?

A “second home” refers to a residential property that individuals intend to occupy for part of the year, alongside their primary residence.

To secure a mortgage loan for the purchase of a second home, specific criteria are typically in place. The property should be situated in a resort or vacation destination, such as mountainous regions or coastal areas, or be located a certain distance away from the borrower’s primary residence, usually at least 50 miles. Additionally, borrowers are required to meet credit and other underwriting conditions to qualify.

Examples of Second Homes:

Second homes typically serve as vacation residences, but they can encompass various scenarios. For instance:

Vacation Getaway: Many second homes are used as vacation homes, offering a retreat from daily life. These properties are nestled in scenic locales like beachfronts, mountain escapes, or serene lakeside settings.
City Pied-à-Terre: In urban settings, a second home might take the form of a pied-à-terre, a place to stay during regular business trips or city visits. It provides convenience and a familiar base in the heart of a bustling metropolis.
Regularly Visited Properties: Some second homes are chosen for their frequent visits. For instance, a condo in a city where business activities often occur allows for a comfortable and reliable stay during work-related trips.

These examples illustrate the diverse nature of second homes and the range of purposes they serve, from leisurely getaways to practical solutions for those with multiple locations for work and relaxation. Second homes offer a way to enjoy different surroundings while maintaining a primary residence as a central base of operations.

How Are Investment Properties and Second Homes Alike?

Investment properties and second homes share similarities as they are both properties used without being your primary residence. For both, property owners are responsible for maintenance, repairs, property taxes, insurance, and utility bills. Both types of properties can potentially increase in value over time, and owners may be eligible for specific tax deductions or benefits.

Mortgage loans are accessible to qualified borrowers seeking to purchase an investment property or a second home. However, the terms and interest rates can differ based on various factors, including your credit history, the lender you choose, and other individual circumstances.

How Do Investment Properties and Second Homes Differ?

In simple terms, when you purchase property with the primary intention of making a profit and not as a personal residence for your family’s occasional use, it falls under the category of an investment property. Second homes, on the other hand, are primarily meant for personal enjoyment and relaxation.

Securing a mortgage for a second home is typically more affordable and less complicated than obtaining one for an investment property. However, both types of properties involve stricter lending requirements compared to primary residences.

Mortgage Rates

Your mortgage rate is significantly influenced by the property’s “occupancy.” There are three categories: primary, second home, and investment. Lenders often charge higher interest rates for second homes and investment properties due to the risk associated with these property types. In financial hardship, homeowners prioritize their primary residences, leading lenders to increase interest rates by 0.50 to 0.875 percentage points over primary residence rates. If you have a low credit score and make a small down payment, the rate difference may be even more pronounced.

Down Payments

Investment properties generally require a larger down payment than second homes to mitigate the risk of default. A typical minimum down payment for a second home is 10%, while a single-family investment property may demand 15% to 20%. If you’re purchasing a two- to four-unit multifamily investment property, you could be looking at a down payment of up to 25%. However, homebuyers willing to reside in one unit of a multifamily home for at least a year may qualify for an FHA-backed loan with as little as 3.5% down. The VA guarantees no down payment loans for eligible military borrowers, allowing the purchase of properties with up to seven units provided they live in one of them.

Qualification Requirements

Meeting the requirements for a second home or investment property mortgage is typically more challenging than for a primary residence. Many lenders demand a minimum credit score of 720 for second home purchases and 700 for investment properties with the lowest allowable down payment. Additionally, they might require you to have sufficient cash reserves to cover two home payments for up to six months. You’ll also need to demonstrate adequate income to cover both properties. In most cases, rental income from an investment property cannot be used for qualification unless your tax returns demonstrate property management experience.

Rental Income

To offset the mortgage payment on your investment property, you might be able to include up to 75% of expected rental income. However, lenders offering this option may necessitate a specialized appraisal analyzing local rent prices. This specialized appraisal can make investment property appraisals more costly than regular ones. Furthermore, some lenders might require you to prove prior rental property management experience to credit you for potential rent income. An exception is the FHA loan program, which permits lenders to factor in anticipated or actual rental income on a two- to four-unit property, even if you lack landlord experience, as long as you reside in one of the units for at least 12 months.

Choosing Between Investment Property and Second Home: What to Consider

To decide between an investment property and a second home, start by defining your purpose for the property: profit or personal enjoyment. Then, if you’re financing the purchase, examine loan terms, as investment property loans typically carry higher interest rates and demand a larger down payment (around 20%) compared to second home loans, which usually offer lower interest rates.

Additionally, choose the right location, taking into account the rental market (if applicable) or the property’s appeal as a vacation destination. Lastly, carefully evaluate all associated costs, including mortgage payments, property taxes, insurance, and potential income, to make an informed decision on property type and whether it’s a wise investment.

How Do I Finance an Investment Property or Second Home?

When it comes to financing, securing a mortgage for a primary residence is more straightforward and cost-effective. During financial challenges, people prioritize payments for their main homes, leading to stricter lending requirements for second home and investment property loans in comparison to primary residences.

Both second home and investment property mortgages necessitate higher credit scores and more substantial down payments than primary residence loans. Additionally, you may need to demonstrate financial reserves sufficient to cover payments for up to six months and have the income to support two mortgage payments (primary residence and second home or investment property).

Generally, rental income from an investment property cannot be used for qualification, unless your tax returns confirm property management experience, with certain exceptions. To gain further insights, consult with a mortgage lender.

It’s generally more affordable and easier to secure a second home mortgage compared to financing an investment property, which typically presents more substantial challenges.

Stamp duty rules for second homes

Since September 2022, stamp duty on second homes has incurred a higher rate than the standard rate for primary residences, with an extra 3% surcharge. Stamp duty is a tax applicable when purchasing property or land, calculated on a tiered scale. The value of the property determines the amount of stamp duty payable.

For your primary residence, the initial £250,000 incurs a 0% charge, but for a second home, this amount is subject to a 3% charge, and so on, increasing through the subsequent tiers. As an example, if you acquired your first property for £200,000, there would be no stamp duty to pay, whereas for a second home, you would owe £6,000.

This surcharge is not applicable to second homes valued below £40,000 or to properties classified as ‘movable.’ If you intend to purchase a caravan, mobile home, or a houseboat, you would be exempt from stamp duty (though mortgages are generally not available for these properties).

Even if you’ve purchased a second home with the intention of eventually making it your primary residence, you are still obligated to pay the additional 3% surcharge. However, if you sell your first property within three years, you can seek a refund from HMRC for this amount.