Should Your First Home Be an Investment Property?

Weigh the pros and cons of buying a property for profit

A real estate agent shows a home to a potential buyer.
•••

The Good Brigade / Getty Images

Many first-time homebuyers are often shopping for a starter home to live in. Others, however, may be more interested in investment opportunities.

When you buy a property with the goal of earning profit, you can start building equity with homeownership while also potentially generating income to cover the mortgage. On the downside, buying an investment property as your first home does have risks.

Learn the pros and cons of buying an investment property as your first home so you can determine if it’s the right move for you.

Key Takeaways

  • The goal of buying an investment property is to generate additional income and/or a future capital gain.
  • If your investment property is owner-occupied, you can take advantage of more favorable lending and tax rules.
  • Risks of buying an investment property as your first home include the chance that the property does not appreciate, or that your expenses exceed your income.
  • The eligibility requirements for loans for an investment property tend to be more strict.

What Is an Investment Property?

Investment property is real estate you buy to generate income and earn a profit. You could make money by renting the property or selling it for a profit, or both.

There are two ways you could approach buying an investment property as your first real estate purchase, Brian Davis, a real estate investor and founder of SparkRental.com, told The Balance in an email.

“The first is buying a property with the intention to move in, and then renting part of it out to help cover your housing costs,” Davis said. Many homebuyers taking this strategy buy a multifamily property, then live in one unit while they rent out the other(s). “Ideally, your neighboring renters cover your entire mortgage payment, plus some extra for ongoing maintenance and repairs.”

A second strategy is to buy an investment property with no plans to live there. You rent it out to tenants with the goal of selling it for a profit after several years of appreciation. With this strategy, lenders often charge higher rates for mortgages than they charge for mortgages on owner-occupied homes, Davis said.

You’ll also want to factor in tax considerations when choosing whether to buy an investment property as a starter home. “When you purchase an investment property, it gets taxed differently from your primary residence,” Ruth Shin, founder and CEO of PropertyNest, told The Balance in an email.

For example, you can depreciate your residential investment property, but not for a home you own and live in. You can also claim operation-related deductions on your taxes in addition to mortgage interest (which most homeowners can deduct), including taxes, advertising, maintenance, utilities, and insurance.

Types of Investment Properties

You have several options when it comes to the type of investment property you choose to purchase. Some common types of investment properties include:

  • Apartment building
  • Condo
  • Duplex
  • Single-family home
  • Townhome

When purchasing an investment property, you’ll need to decide whether or not you’ll live in it.

An owner-occupied property means the person who holds the title also lives there. Usually, you have to use it as your primary residence for a minimum of 12 months. These types of properties tend to come with financing options that have lower rates.

Non-owner-occupied homes are investment properties in which the owner doesn’t reside. Loans for these types of properties have higher default rates, so lenders often charge higher interest rates and have stricter lending requirements.

Pros and Cons of Investment Properties as First Homes

Pros
  • Source of income

  • Increase net worth

  • Tax benefits

Cons
  • Expenses could outweigh income

  • Tougher financing criteria

  • Less liquidity

Pros Explained

  • Source of income: Buying a property that you can rent to tenants allows you to collect rental income. A tenant’s rent can go toward paying your property’s mortgage. You can use any additional monthly income for investing, saving, or spending.
  • Increase net worth: Over time, real estate generally appreciates in value. Increased equity adds to your net worth and serves as a return on investment when you eventually sell the property. You can also leverage equity in your home through home equity loans.
  • Tax benefits: In addition to writing off some or all of your mortgage interest, an investment property can provide tax breaks on costs for maintenance, utilities, insurance, and more.

Cons Explained

  • Expenses could outweigh income: Owning a home comes with many costs. While rental income can help cover those expenses, you may face times when they do not, such as between tenants. Major expenses such as repairs or property taxes could exceed the rental income. And while property tends to appreciate, there’s always a chance your property’s value could decline.
  • Tougher financing criteria: Depending on the type of financing you qualify for, you may need to save up a larger down payment or have more cash in reserves. Or you may need to have a higher credit score than you would need for a mortgage on a primary home.
  • Less liquidity: Money invested in property is less accessible than money invested in stocks, bonds, or other more liquid investments. If you need to access a large sum of money, you have to go through the process of selling your property, which takes time and has expenses.

How To Finance an Investment Property

If you don’t have the funds to purchase an investment property outright, you’ll need to take out a loan. The types of loans available depend on what type of property you’re financing and the occupancy status.

For example, as a first-time homebuyer, you may benefit from an FHA loan. These loans are backed by the Federal Housing Administration (FHA), which allows lenders to offer more favorable terms. It’s possible to qualify for a down payment as little as 3.5% with a credit score as low as 580, for instance. FHA loans are available on properties with up to four units. However, you have to occupy one of them to qualify.

Another option is a conventional mortgage loan for an investment property, which works similarly to a mortgage on a primary residence. However, the eligibility rules may be stricter. “Typically, you need to have even stronger finances than for a conventional mortgage to qualify,” Shin said. That means stronger credit, assets, and cash reserves.

You may have a higher down payment for a mortgage for an investment property. You should also have a credit score in the “good” to “excellent” range, and about six months’ worth of cash reserves at a minimum.

Should Your First Home Be an Investment Property?

Buying an investment property for your first home can be a smart move. However, it comes with some major risks and challenges. In other words, it's not for everyone. Here’s how to tell if buying an investment property is something you should consider pursuing.

When To Buy an Investment Property as a First Home

Prospective homeowners on solid financial footing are good candidates for investment properties. Because the lending standards tend to be higher, you should have plenty of savings set aside and few debt obligations.

Your credit also needs to be in good shape. Also consider that if you plan to rent out part of the property, you need to be well aware of the laws for landlords and tenants, and have enough time available to manage your property.

When Your First Home Shouldn’t Be an Investment Property

If you have an unpredictable income, high debt load, or little savings, buying an investment property for your first home can be risky.

You may be better off purchasing a smaller starter home and working your way up to a larger property. Also, consider whether you have the time and patience to manage multiple units and tenants. If not, you’ll need the extra funds to hire a property management company. Or you’ll need to focus on investing in a property for the equity (or not investing at all).

Frequently Asked Questions (FAQs)

How do you buy an investment property with no money down?

Buying an investment property with no money down is possible, but not as easy as borrowing with a down payment. You may need to turn to alternative financing methods such as private lenders, seller financing, rent-to-own properties, real estate partnerships, or hard money lenders. Keep in mind these options may come with higher risks and costs.

What is the loan document that says whether or not the property is an investment property?

An occupancy affidavit or statement of occupancy is a legal document that indicates how a financed property will be occupied. Lenders need to know whether a property will be a principal residence, second home, or investment property because that dictates the risk level and eligibility rules for borrowing.

Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!

Article Sources