The Mortgage Brothers Show
Second home Mortgage vs. Investment Property Mortgage. What’s the difference?
In this episode, as we often do, we talked about mortgages. There are two different types of financing we do outside of that for primary residences — second homes and investment properties. For the full story, be sure to listen to the full podcast above or on Apple Podcasts. For now, let’s get into the overview.
A second home is not always a second home.
We recently had a borrower ask us if they could buy a house here in the Valley for their son to live in as a second home. They weren’t even going to charge him rent. Unfortunately, he can’t do this. A second home is not so simple as a second home that you own. It is a specific categorization. A second home loan is for someone who is going to be occupying the home for part of the year, 50% or less.
Where we are in Phoenix, people tend to escape up to the north to their cabins and second homes, so vacation homes are what we most often deal with if we’re going to do a second home. Typically, second homes are considered places of leisure, a place you go for a small part of the year. When you apply for these loans, you’re going to have to write a letter explaining why you’re buying this place and why you’re making it a second home. Your intentions will have to be clear and believable.
Let’s look at another example.
Say, it has nothing to do with vacationing and you purchased a home so you could take care of a member of your family. In certain circumstances that’s totally fine. If you live in Phoenix and you’re taking care of a family member in Tucson, you can categorize it as a second home given that you spend time living there. But if you’re in Phoenix and, say, your grandmother lives 30 minutes away from you, you can’t buy a house next to her and call it your second home.
It’s all about the intent. If you intend to occupy it as a vacation home, what you do with it the other remaining part of the year is up to you. But if your intention is to call a lender and to tell them that you want to get second home when you’re really going to be renting it the entire time, that’s when that stuff can become messy and come around and bite you.
And since second homes is a categorization you can even have a second, second home, which is a bit of a fun — and in many cases useful — fact.
Now an investment property is any property that you don’t live in. Typically, they’re homes that you rent, but they don’t have to be. Looking back at our first example, you can let a family member live in your investment property.
So, what’s the difference in rates between second home and investment mortgages?
Typically, a second home is going to be very close to what a primary is. There are only a couple of little adjustments, but usually, it’s the same pricing. But, when it comes to investment properties, interest rates are about 1% higher than on a primary residence. Now, that’s in a typical market, but right now, in a market when the banks are uncomfortable — recessions, pandemics, etc. — they’ll actually make that delta, that spread, higher. So, right now, you might see about 2%. The reason they do this is that when the markets are unsure, the risk is higher on the investment properties. If the market all of a sudden took a crash, borrowers are going to dump that loan. Before they foreclose or go late on a primary residence, they’re going to go late on an investment property.
Things, such as debt-to-income ratios and loan-to-values, as well, are a bit stricter on investment properties than on second homes and on second homes than on primary residences. But a lot just comes down to a borrower’s history, their credit and job history, and how that impacts the underwriting.
One way, though, to avoid higher interest rates on investment properties is to put more money down. In those cases, the rates go down a bit. You need to put at least 25% down to get better pricing.
Speed Round of FAQs
Are you allowed to have overnight rentals like Airbnb in second homes?
And are there limits regarding how many nights you can rent?
No. From a lending perspective, we’d never tell you how many nights you can or cannot rent. But from a qualifying income perspective, this becomes an issue when we’re talking about vacation rentals by owner. We suggest checking with your city. They might have a different ruling or the community itself may have a restriction. If the for-rent-by-owner property is the subject property, we’re going to have an issue from a qualifying income perspective because some of these VRBOs are making a lot of money and we can’t count it because short-term leases cannot be underwritten.
Can a second home be multiunit? Or is it just one unit?
You can do up to four units in both primary, second homes, and investment properties, but after four, commercial financing is triggered.
Can you have an accessory dwelling unit that is defined as a casita or guest house of your second home or investment property?
You can. Although, if you buy a property and are renting out the back you won’t be able to count that as income. The reason for this is that though it’s a detached structure, it’s still defined and grouped in with that property. So, if you’re vacationing in it, why is a part of your vacation being an investment property? So that’s when you’d end up triggering probably the investment category. But, again, you can always stair step down. If you really want this to be a second home and it’s just not being underwritten, just say, “Forget second home. We’re going to go investment.”
Thanks for listening and reading the Mortgage Brothers Show. Let us know if you have any questions you’d like us to answer on this podcast. You can email your questions to Tom@AZMortgageBrothers.com or Eddie@AZMortgageBrothers.com.
Be sure to ask us for a free quote on your next mortgage. We’ll personally work with you and help you through the whole process.
Signature Home Loans LLC does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. Signature Home Loans NMLS 1007154, NMLS #210917 and 1618695. Equal housing lender.