Updated May 22, 2023
Deciding between a second home or full investment property? Learn the differences between the two including mortgage considerations and tax
Are you considering purchasing a second property? Even if you’re not planning to move, you may want a place to vacation or to rent out for income. In fact, you might plan to use the same real estate property for both purposes. But before you start shopping and worry about how to afford a second home, it’s important to understand that the way you use a second property can impact your monthly mortgage payment and tax bills.
In the eyes of the IRS (and your mortgage lender), there’s a difference between a second home and an investment property.
In short, you live in a second home part of the time (like a vacation property), whereas you don’t live in an investment property. In this guide, we’ll break down the monthly mortgage payment and tax differences between these two kinds of real estate properties so that you can make the best choice for your financial future. From there, you can decide which home equity loan alternative you’ll use to finance your purchase.
What Separates a Second Home from an Investment Property?
A second home is a place where you live part of the time, but this begs the question: what constitutes part-time?
It all depends on who you ask. The IRS has a different answer than most banks.
The IRS makes this an easy question. They consider something a second home (or dwelling unit) if both of the following apply:
- You personally use the secondary residence for over 14 days a year.
- You personally use the secondary residence for over 10% of the amount of time you rent the residential rental property.
Let’s take a closer look at the 10% rule. If you rent out your home for 200 days during a year, it’s still considered a second home as long as you live in it for 20 or more days (which, happily, also meets that 14-day minimum requirement).
However, if you only rent out the home for 100 days during a year, you would still need to live in it for at least 14 days for it to be considered a second home (rather than 10).
If you rent it out as a vacation property year-round, you won’t be able to meet the minimum of 10 days of residency. In that case, it’s an investment property in the IRS’ eyes.
The difference between a second home and an investment property is all in the eyes of the beholder.
While the IRS is pretty clear about the difference between a second home and an investment property, they aren’t the ones who will be giving you your new second mortgage. Lenders may have stricter requirements to qualify a property as a vacation home. Some of these second home mortgage requirements may include:
- Location – Some lenders will put location requirements on the property to consider it a second home. For instance, it can only be a certain distance (i.e. 60 miles) from your primary home or it will need to be located in a resort or vacation area.
- Limits on rental – Your conventional mortgage lender may have different limits than the IRS does when it comes to what constitutes a second home vs investment property. They may even require that the home be used exclusively by you and not be rented out.
Why do lenders have different requirements than the IRS when it comes to classifying your property as a second home vs investment property? Mortgage considerations. There are three types of mortgages you can receive when buying a property:
- Primary residence
- Second home
- Investment property
It’s easiest to qualify for a mortgage on a primary residence. The logic behind this is simple: a conventional mortgage lender figures if you’re living in a property, you will be less likely to stop paying and risk losing your home. By this same logic, a second home loan will often be easier to qualify for than an investment property loan.
To better understand the difference in second home mortgage rates vs investment property, let’s look at some of the key factors:
- Interest rates – The interest rate you’re offered on a mortgage will vary from lender to lender and will be affected by factors like your credit score, debt-to-income ratio, and down payment. However, interest rates are lowest on a primary residence mortgage and highest on an investment property mortgage, with second home mortgage rates falling somewhere in the middle.
- Down payment – While a higher down payment may get you a more favorable rate for your primary residence, it will likely be required for a second home. You’ll need even more to purchase an investment property. Many lenders will require at least 10% down for a second home. That number can jump to an even higher interest rate of 15-20% for an investment property and even more if your investment property has multiple units).
- Other qualifications – As you can see, lenders are more reluctant to give out mortgages for investment properties and second homes than they are for primary residences. In addition to the different rates and different down payments, other qualifying requirements may include:
While it may seem that getting a mortgage for an investment property is much more difficult than getting one for a second home, investment properties boast one advantage: rental income. Some lenders will accept likely rental income as a factor to help you qualify for your mortgage. However, this may require a second appraisal of the property, and you may have to show previous experience managing rental properties.
Accessing Extra Capital
Whether purchasing a second home or an investment property, it helps to have cash on hand. A sale-leaseback allows you access to your home’s equity with a personalized solution that takes into account your needs and timeline. This can help you avoid having to liquidate other assets to finance your new property.
Claiming the Wrong Type of Property
Since it can be difficult to secure a mortgage for an investment property, some people are tempted to apply for a second home regardless of whether they intend to live in the property.
Do not apply for a second mortgage if you are interested in an investment property. Lenders consider this a crime called occupancy fraud. It could trigger an FBI investigation, and any benefit you received on your mortgage would be erased by the hefty fines you would be assessed if caught.
If your situation does change, you can convert your mortgage from a second home into an investment property. However, you may need to have met certain time requirements before this is an option, and you will be subject to higher rates and different guidelines when you refinance so it is important to look at the pros and cons of refinancing prior.
Beyond the mortgage differences between a 2nd home vs investment property, there are tax implications depending on what kind of property you purchase. For example, a second home can potentially qualify for certain tax benefits, such as mortgage interest and property tax deductions, but these deductions are subject to specific limitations. Investment properties, on the other hand, provide opportunities for capital gains when you decide to sell. However, capital gains tax may apply.
The main differences in tax implications relate to:
- Second home – You can deduct the interest on your mortgage along with the property taxes and any mortgage insurance for a second home. The maximum allowable tax deduction is $750,000.
- Investment property – Mortgage interest will be part of your expense write-off.
- Second home – An expense write-off is not allowed.
- Investment property – In addition to mortgage interest, you can write off expenses such as maintenance, utilities, and depreciation.
- Second home – Income from a second home is not taxed if you rent for fewer than 14 days during the year. If the property is rented for more than 14 days, income must be reported.
- Investment property – Any rental income must be reported.
This is just a quick guide, and specific tax laws can be complicated. It’s likely worth talking to a professional for tax purposes and your requirements to ensure no mistakes are made.
The Verdict: Which is Better?
When trying to decide between a second home and an investment property, neither can truly be said to be better than the other. They each serve different purposes, and there are different rules governing both.
The benefits of a second home include:
- The ease of securing up-front financing
- The luxury of a second place to vacation with your family
- The possibility to rent the home (depending on your mortgage agreement)
The benefits of an investment property include:
- The potential to make rental income that offsets the cost
- The possibility of occasionally using the home or a unit within it
- The ability to write off expenses
When it comes to deciding between the two, consider your current finances and your long-term goals.
Convert Your Home Equity with a Sale-Leaseback
Whether you’re looking for a second home or an investment property, a sale-leaseback may be able to help. Wondering how to buy a second home with no down payment or how to fund your investment property purchase? Traditional lenders can make it difficult to finance new property purchases.
A sale-leaseback program allows you to sell your home and convert your home equity to cash. The catch is that you get to still lease your home back. With the cash from your home equity on hand, you’re free to use it for a second home or investment property.
This gives you the time and money to reach your goals, all without taking on additional debt.
Deciding between a second home or full investment property? Learn the differences between the two including mortgage considerations and property tax. If you are still unsure of a fit solution for either an investment property or second home purchase after reading this article, consult a financial advisor to discuss your options.
This article is published for educational and informational purposes only. This content is based on research and/or other relevant articles and contains trusted sources, but does not express the concerns of EasyKnock. Our goal at EasyKnock is to provide readers with up-to-date and objective resources on real estate and mortgage-related topics. Our content is written by experienced contributors in the finance and real-estate space and all articles undergo an in-depth review process.
- IRS. IRS Publication 527. https://www.irs.gov/pub/irs-pdf/p527.pdf
- NOLO. What Is the Difference Between an Investment Property and a Second Home? https://www.nolo.com/legal-encyclopedia/what-the-difference-between-investment-property-second-home.html
- Value Penguin. Second Homes vs Investment Properties: Mortgage Terms and Tax Rules. https://www.valuepenguin.com/mortgages/second-homes-vs-investment-properties