Tuesday, October 31, 2023 / by Sonya Reiselt
When purchasing a second home in the Lowcountry, it is important to note that the mortgage rules differ from those of your primary residence. It is also crucial to understand the distinctions between buying a second home and an investment property, as these terms are often used interchangeably.
The Meaning of “Second Home”
A second home is a property where you reside for part of the year, in addition to your primary residence. It is typically a vacation home, but it can also serve as a place for work purposes. For instance, you may own a condo in a city where you frequently work, even though it is not your primary residence.
When considering a mortgage for a second home, it is important to note that it will typically need to be located in a vacation or resort area (such as right here in the Beaufort area), or meet a specific distance requirement from your primary residence.
A second home loan typically offers a lower interest rate compared to an investment property loan. Additionally, your loan will likely include a Second Home Rider.
As the borrower, you will occupy the property and use it as your second home. The property cannot be part of a rental pool or timeshare agreement, and there cannot be agreements requiring you to rent the property or give a management company or third-party control over the property's use.
Each lender has their own specific requirements that may differ from the general definition provided above. It is important to be aware of these individual requirements when seeking a loan.
When it comes to getting a second home loan, it's important to know that different lenders have different policies. Some lenders may not approve your loan if you plan to rent out your home, while others may be more flexible. However, even if you do plan to rent out your home, some lenders may still approve your loan as long as you commit to staying in the home for a certain number of days each year. It's always a good idea to check with your lender to understand their specific requirements and options.
What About Financing An Investment Property?
Understanding the differences between a second home and an investment property is crucial because the financing process varies significantly. Financing a second home is generally much easier compared to an investment property.
When considering a second home mortgage, it's important to note that the interest rate is typically similar to that of a primary home. Additionally, the credit requirements for a second home mortgage are generally aligned with those for buying a primary home.
Qualifying for an investment property mortgage can be more challenging, with higher interest rates and origination fees.
Investment property mortgages have their own benefits. Lenders are often more willing to provide loans for investment properties because they expect the property to generate enough cash flow to cover the loan and other expenses.
What About the IRS?
According to the IRS, the distinction between a second home and an investment property is based on usage. To be considered a second home, you must use the property for at least 14 days each year or 10% of the days you rent it. If you do not meet this standard, the property is classified as an investment property.
Why does it matter?
If you own a second home, you may be eligible for a mortgage interest tax deduction. This deduction can be applied to interest paid on up to $750,000 in qualifying residential debt. If you have an investment property, you can also utilize this deduction, but in this case, you can deduct the mortgage interest as a rental income expense.
Additionally, as the owner of an investment property, you can claim an annual depreciation expense, which can reduce the taxable amount of your rental income. It is important to note that regardless of how the home is classified by the IRS, if you both use it personally and rent it out, you will need to divide expenses based on the time it is rented and the time you use it personally.
It is important to be honest when stating your intended use of the property. Fudging the truth can be considered mortgage fraud, which is illegal.
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