Key takeaways
- Lenders tend to have stricter criteria for investment property mortgages than for second home mortgages.
- The amount of time you’ll personally use the property determines how it is classified for taxes, and thus for a mortgage loan, with 14 days being the key cutoff.
- Both investment property and second home mortgages are harder to come by compared to a loan for a primary residence.
Owning more than one property is an enviable position to be in, but how you classify that property makes a difference in how much you’ll pay to finance and own it. If you use it as a second home, a place to go for vacations or other extended periods, there’s one set of mortgage requirements and rules. If it’s more of an investment property, source of a stream of rental income, there’s another. There are differences in tax treatments, too.
When determining whether to buy a vacation home vs. an investment property — or how to classify it for your loan application — this is what you need to know.
Second home vs. investment property definitions
There is a key difference between second home and investment property loans, and it all has to do with how you plan to use the place.
- Second home: A second home is an additional residence — one you purchase for personal use/enjoyment and live in or visit during part of the year.
- Investment property: An investment property is one you plan to rent out with the goal of generating income.
Of course, a property can sometimes serve both purposes. That’s true especially if you’re thinking about occasionally renting out the property when you don’t want to use it. Earning some money from your property doesn’t automatically make it an investment, however.
So how do you differentiate? Accurately defining the piece of property depends on how much time you spend in it. In a nutshell, it comes down to “the 14-day limit rule,” says CFP Elliot Pepper, co-founder of and director of tax services at Northbrook Financial, a Baltimore financial planning firm.
“Broadly speaking, if you personally live in your second home for 14 days or fewer — or less than 10 percent of the days it is rented — during a year, then it would be considered a rental property and the income earned would be taxable,” he explains. “But you would also deduct the expenses associated with the property.”
On the flip side, if you use the property for more than 14 days or more than 10 percent of the time it’s rented, any rental income you receive isn’t taxable — but you also can’t deduct expenses, says Pepper.
Second home vs. investment property mortgage requirements
Making the distinction between a second home vs. investment property is important not only for tax purposes but also when you seek financing for the home. Clear distinctions exist in the criteria for second home mortgages and investment property mortgages.
Second home lender requirements | Investment property lender requirements | |
|---|---|---|
| Credit score minimum | 620-680 or higher | 700 or higher |
| Down payment minimum | 5%-10% | 15%-25% or more |
| Debt-to-income (DTI) ratio maximum | 45% | 45% |
While the requirements differ, both types of properties share one big trait: Both are riskier prospects for lenders than a primary residence. That’s because if you were in a financial bind, you’d likely prioritize paying the mortgage on your main home versus a second or investment property.
Due to this added risk, lenders tend to require higher credit scores and down payments on investment property and second home mortgages. For instance, Chase and Navy Federal Credit Union both require a 15 percent down payment for an investment property — in contrast to 3 percent for conventional loans.
Second home vs. investment property tax implications
There are some tax rules to keep in mind when considering a vacation home vs an investment property loan.
Second home tax rules
- Mortgage interest alone is tax deductible, up to the $750,000 total debt limit
- Cannot rent out your property for more than 14 days per year in order to deduct mortgage interest
- Any rental income is non-taxable income (under 14 days a year)
Investment property tax rules
- Mortgage interest is fully tax deductible
- Can deduct many property-related expenses including property tax, maintenance expenses, utilities and insurance
- Rental income is taxable income if the property is rented out more than 14 days per year
Homeowners can deduct mortgage interest, but Pepper points out that this can get tricky if you own a second home, due to the $750,000 total loan limit for interest deductions. If you have more than $750,000 in mortgage debt between the two (or more) properties, you’ve maxed out the amount you can use to deduct interest.
However, “interest on a mortgage related to an investment property is fully deductible on [Form 1040] Schedule E for a taxpayer and can therefore be used to offset any income generated from the property,” says Pepper. “Investment property owners can use depreciation to their advantage, as well.“
For a personal residence, you cannot deduct the actual cost of the home for tax purposes. “However, for an investment property, the taxpayer will be allowed to take a deduction every year for depreciation,” says Pepper. “This deduction is based on the price of the house purchased and will be used to offset any income from the property.”
This deduction isn’t permanent, “as the amount of depreciation taken will reduce the basis in the house. When the taxpayer goes to sell, they may end up with a larger tax gain that year.” This gain is depreciation recapture, and is taxed at higher rates than traditional long-term capital gains.
For more on the tax implications of second homes and investment properties so that you can calculate your eligibility for tax deductions, review IRS Publication 936 and Publication 527.
If you personally live in your second home for 14 days or fewer — or less than 10% of the days it is rented — during a year, then it would be considered a rental property.— Elliot Pepper, co-founder, Northbrook Financial
Second home vs. investment property mortgage rates
As they have with primary residences, mortgage rates for second homes and investment properties have increased in recent years. You’ll also pay higher rates, in general, for investment properties and second homes than you will for a primary residence mortgage loan.
The good news is that mortgage rates are expected to start coming down in 2024. The Fed is expected to cut its primary lending rates about three times this year. When that happens, rates on mortgages should also begin to decline.
Learn more:
- Compare second home mortgage rates
- Compare investment property mortgage rates
Can you call an investment property a second home?
Tempted to call your investment property a second home and take advantage of some of the second-home loan perks, like a lower down payment and interest rate? Don’t be. In the mortgage world, you need to call it what it is. Deceiving a lender or the IRS otherwise could have serious consequences.
