Buying a second home can be much easier and cheaper to finance than buying an investment property. Investment properties can offer you tax deductions by claiming operating expenses and ownership. Secondary residences, on the other hand, can also generate rental income and tax deductions for charges, provided that the owner lives there at least 14 days per year or 10% of the total days rented. Let’s break down the differences.
A Financial Advisor could help you establish a financial plan for the purchase of a secondary residence or an investment property.
Basics of second home and investment property
In addition to a primary residence, owners may have a second or vacation home, as well as investment properties that are rented out to third parties for income. The principal residence is where the owner lives most of the year.
Secondary residences are properties such as vacation homes that the owner personally occupies more than 14 days per year, while maintaining a primary residence. It is possible to have more than one secondary residence.
It is also possible to generate income by renting a second home to third parties for part of the year. The property will meet the definition of a secondary residence, rather than an apartment building, as long as the owner lives there for a number of days equal to at least 10% of the rental days of the house or 15 days per year.
Investment properties have no occupancy requirements. They can be rented 365 days a year to third parties. Rentals can be long-term, such as on an annual lease basis, or short-term. The owner earns money on the investment properties from rental income and appreciation and benefits from tax deductions that he can use to protect his income.
Financing of second homes and apartment buildings
When apply for a mortgage, a borrower must indicate whether the property will be used as a principal residence, secondary residence or investment property. Primary residences are the easiest and cheapest to finance, with looser qualification standards and lower interest rates. Down payments on primary residences can be as low as 3% of the purchase price on conventional loans, 3.5% on FHA loans, and zero on VA loans.
Loan requirements on second homes are stricter. Lenders are likely to seek a lower debt-to-equity ratio to ensure the buyer can cover the second mortgage payment, for example. Second home mortgages may require a 10% down payment. Interest rates are also likely to be slightly higher than mortgages on principal residence. Except for a few special circumstances, FHA loans cannot be used to purchase second homes.
Investment properties are the most difficult to finance. Lenders require down payments of around 25% and also prefer higher credit scores. Government-backed loan programs generally cannot be used to purchase investment property. Financing an investment house will likely involve paying more interest and additional fees to the lender. However, borrowers can often use projected rental income to qualify for an investment mortgage.
Taxes on second homes and investment properties
Like principal residences, secondary residences with a mortgage can offer the owner a tax deduction for the interest on the loan. Owners of second homes who rent them part-time may be able to reduce the amount of taxable rental income by deducting expenses related to home ownership. To qualify for these deductions, the property must be rented at fair market value for more than 14 days or at least 10% of the total number of days rented per year.
Investment residences also offer a host of tax deduction Opportunities. Homeowners can claim expenses for mortgage interest, property taxes, insurance, maintenance, utilities, and damage losses. They can also deduct a percentage of the value of the property each year due to depreciation.
Second homes and investment houses are viewed differently by lenders and tax authorities. Secondary residences are more difficult and more expensive to finance than primary residences. Loans for investment houses generally involve more costs and are more difficult to obtain. Second homes can offer tax breaks, as well as the opportunity to generate part-time rental income. The expenses of owning an investment home can help protect rental income from taxes.
Tools for buying real estate
- Whether you are buying a second home or an apartment building, a Financial Advisor could help you create a financial plan tailored to your needs. SmartAsset’s free tool connects you with up to three financial advisors who serve your area, and you can interview your advisors at no cost to decide which one is best for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
- If you’re not sure how much money you’ll need to buy a home, SmartAsset’s free calculator might help you figure it out. how much house you could afford.
- Smart Assets mortgage calculator allows you to estimate your monthly mortgage payment with taxes, fees and insurance.
- Use our mortgage comparison tool to compare mortgage rates from top lenders and find the one that best suits your needs.
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