Although they may appear similar on the surface, second homes and investment properties are quite different. If you’re thinking about buying a new property, deciding which type you’re going to buy is a crucial first step. The choice of vacation home or investment property will affect your mortgage rates, down payment requirements, and even whether you qualify for tax deductions. Let’s take a look at second homes vs. investment properties to help you decide which one is right for you.
What’s the Difference Between a Second Home and an Investment Property?
|Second Home||Investment Property|
|Purpose||To live in on vacation; often in a different location than your primary residence||Solely to generate income|
|Mortgage rates||May be higher than for a primary residence but lower than for an investment property||Often higher than for a second home or a primary residence|
|Down payment requirements||Higher than for a primary residence, lower than for an investment property; may be as little as 10%||Higher than for a second home or a primary residence; typically between 15% and 25%|
|Other qualifying requirements||Must be able to cover two mortgages (if you haven’t paid off your primary residence); may have geographical, property type, or use restrictions||May need proof of rental income|
|Tax treatment||Can claim some deductions; taxes depend on whether and how often you rent it out||Must claim income on taxes; can claim some deductions|
A second home is a property you buy to visit on vacations, one you don’t plan to live in full time. For example, you might buy a cottage to visit on summer weekends, or a condo at a ski hill for winter vacations. Although you may choose to rent out your second home when you’re not using it, your personal use of the home means the IRS considers it a vacation home. How often you rent it will affect your taxes (see below).
An investment property is a home you’ve purchased to generate income, with no intent to live in it. You may plan to rent it out, to eventually sell it for a profit, or both.
Mortgages for both second homes and investment properties often come with higher rates than you’d get on a mortgage for a primary residence—though your rate will vary based on factors like your credit, debt-to-income ratio, type of mortgage, and term.
However, you’ll typically receive a higher rate for an investment property mortgage than a second home mortgage because many lenders view investment property mortgages as riskier than those for second homes. Since you won’t use the property yourself, they may believe it would be easier for you to walk away from it and default on your mortgage.
Down Payment Requirements
Since many lenders view investment properties as riskier than second homes, they’ll often want you to put down more money from the start. You can expect to pay 15% to 25% of the sale price as a down payment for an investment property, potentially depending on its size. However, for a second home, you may be able to put down as little as 10%, depending on your lender.
Other Qualifying Requirements
To qualify for a mortgage on a second home while you’re still paying down your first home loan, you’ll need to be able to prove that you can handle the payments for both mortgages. But when you’re buying an investment property, your lender may consider up to 75% of your anticipated rental income as part of your qualifying income. This allows you to lower your debt-to-income (DTI) ratio and may make it easier to qualify for an investment property mortgage.
Since your second home is generally considered a vacation home or a getaway, your lender may impose geographical restrictions, such as that it must be located a certain distance away from your primary residence. Investment properties face no such restrictions.
Your lender may also limit the type of property they’ll allow you to buy as a second home. For example, Fannie Mae requires that your second home is:
- A single unit
- Under your exclusive control
- Occupied by you at least once a year
- Suitable for year-round occupancy
- Not a timeshare.
Taxes can get complicated for both second homes and investment properties, especially if you rent them out. To understand your tax obligation for your second home, you’ll need to calculate how much time was personal use versus rental use. If you use the property for more than 14 days or more than 10% of the number of days you rent it out, you won’t be able to deduct all your rental expenses. However, you may still be able to itemize deductions such as the personal portion of mortgage interest and property taxes on Schedule A.
If you rent out your second home for less than 15 days a year, you’ll fall under a special exception. You won’t need to report your income to the IRS as long as you don’t deduct any rental expenses.
In most cases, you must report all income from an investment property on your tax return. However, you’ll be able to deduct rental expenses such as repairs, utilities, depreciation, cleaning, and mortgage interest.
Should You Buy a Second Home or an Investment Property?
If you’re looking for a place to visit on the weekends or seasonally and you have enough income to cover another mortgage, buying a second home may be right for you. You could even opt to rent it out when you’re not staying there, though you’ll want to be sure not to violate the terms of your mortgage agreement or home insurance. A second home could also be a good option if your workplace is quite far from your home and you need a place to stay during the workweek.
However, if you’re looking for a way to make money by renting or flipping real estate, you may want to consider an investment property.
The Bottom Line
Second homes and investment properties have major differences in terms of what expenses you can deduct, whether they can be rented out, and even the down payment and mortgage qualifications. Before you call a lender or real estate agent, make sure you consider which option is the best fit for your needs.
Frequently Asked Questions (FAQs)
Can you buy an investment property with no money down?
No, you can’t buy an investment property without a down payment. Typically, you’ll put down up to 25% of the sale price.
Can you buy a second home with no money down?
In general, no, you can’t buy a second home without a down payment. Although you won’t pay as much as for an investment property, you can expect to put down a minimum of 10% on your second home.
What should you look for in an investment property?
It depends on how you intend to use your investment property. While you’ll want to be sure you can derive some type of income from the property, it could be from long-term rentals, seasonal or short-term rentals, renovating the property for resale, or simply holding it until it appreciates enough in value to be sold for a profit.
What should you look for in a second home?
A second home is somewhere you’ll be spending time, so you’ll want to make sure it’s comfortable for you. Consider the location and amenities, as well as the distance from your primary residence. Also look into any extra costs you might incur, such as condo association fees or snow removal expenses.
Department of Veterans Affairs. "Chapter 3. The VA Loan and Guaranty," Pages 3-5. Accessed Oct. 7, 2021.
U.S. Department of Housing and Urban Development. "Section B. Property Ownership Requirements and Restrictions," Pages 4-B-9. Accessed Oct. 7, 2021.
Fannie Mae. "Eligibility Matrix," Page 2. Accessed Oct. 7, 2021.
Pacific Residential Mortgage. "Using Rental Income to Qualify for a Mortgage." Accessed Oct. 7, 2021.
IRS. "Topic No. 415 Renting Residential and Vacation Property." Accessed Oct. 7, 2021.
IRS. "Publication 527 (2020), Residential Rental Property," See "1. Rental Income and Expenses (If No Personal Use of Dwelling)." Accessed Oct. 7, 2021.