Primary residence, second home, or investment property: What’s the difference?

Published September 3, 2020
Lauren Michael (NMLS ID: 1705573)
by Lauren Michael (NMLS ID: 1705573)

When you apply for a mortgage, you’ll be asked how your property will be used—as a primary residence, second home, or investment property. How you categorize the home will affect the mortgage rates available and the requirements needed to be approved for a home loan.

How property occupancy can affect your mortgage

The intended use of your property will affect the interest rates available and the requirements needed to get a mortgage for the home. This is because lenders must assess the level of risk in providing you a mortgage, meaning they determine how likely it will be that you pay back your loan. The riskier the loan situation, the higher the rates and more stringent the requirements for approval will be. While you’ll need to check with your lender for specifics on qualifying for each mortgage type, here are some things to keep in mind.

How lenders define a primary residence

A primary residence is the place where you will most likely live and spend most of your time. Primary residence mortgages can be easier to qualify for than other occupancy types and can offer the lowest mortgage rates.

Lenders view them as properties because homeowners are more likely to stay on top of payments for the roofs over their heads.

For the property to qualify as a primary residence, the following criteria must be met:

  • You must live in the home for the majority of the year.
  • The home must be located within a reasonable distance from your place of employment.
  • You must begin living in the house within 60 days of closing.
  • If you refinance the mortgage for your primary home, you must be able to prove your residence through documentation (e.g., tax returns or government identification).

Obtaining a mortgage for a primary residence

Lenders usually offer the lowest interest rates for primary residences because they believe you are most likely to repay a loan for the home in which you are actually living. If you default on your primary home mortgage, the consequence of not paying would be most severe because you could essentially become homeless. Primary residences also have the lowest down payment requirements, with some conventional loans offering a minimum down payment of just 3%.

TIP: If you’re interested in earning rental income from your home, consider looking into buying a multi-unit property. As long as you live in one of the units, lenders may be able to classify the property as a primary residence, which can help you obtain lower interest rates and down payment requirements.

How lenders define a second home

If you want to buy a vacation home, then your property will likely be classified as a second home. A second home classification depends on how you plan to occupy the property, not whether it is actually the second home you’ve ever bought or currently own.

Your property will be considered a second home if it meets these conditions:

  • You must live in the house for some part of the year.
  • The home cannot be subject to a rental, timeshare, or property management agreement.
  • The borrower must have exclusive control over the property.
  • The home must be a one-unit dwelling, and must be suitable for year-round occupancy.

TIP: If you don’t plan to live in this property full time, keep in mind that the home’s location can affect whether it’s considered a second home. If you choose a place too close to your primary residence, it may be classified as an investment property, which could mean higher mortgage rates and stricter qualifying requirements.

Obtaining a mortgage for a second home

Second home loans may have higher interest rates than primary residences because they represent a greater level of risk. Because you’re not dependent on your second home for a place to live, lenders assume that you may be more likely to stop making payments on the loan if you fall on hard times.

To qualify for a second home mortgage, you may also have to meet higher credit score standards, have a down payment of at least 20%, and meet specific cash reserve requirements. Reserve requirements mean you must have enough money in liquid savings to cover the mortgage for a few months if need be.

How lenders define an investment property

If you’re thinking of buying an additional property with the sole purpose of renting it out or earning income from it, then it would be considered an investment property. Investment properties tend to have the highest interest rates and down payment requirements of all property types. This is because lenders consider non-owner-occupied homes to have an added level of risk because tenants would not likely have the same attention to maintenance and upkeep as owners living in the property.

Your property will likely be considered an investment property if:

  • The home is within 50 miles of your primary residence.
  • You will not be living in the property, and you plan on collecting rent or lease payments from it.
  • You intend to earn a profit by flipping the property.

If you’re looking to rent or lease the home, you may need to submit a lease agreement that confirms the property is occupied by a tenant.

Obtaining a mortgage for an investment property

Investment property mortgages come with the most stringent qualifying criteria because they tend to have higher delinquency rates than other occupancy types. People are more likely to prioritize paying the loan for a home they use before one that’s simply used to generate additional income.

Investment property mortgages usually come with the highest interest rates, credit score requirements, and liquid asset requirements of the three property occupancy types. You’ll also likely need a minimum of 20% for a down payment.

TIP: Keep in mind that you may not be able to include your future earning potential from the home as part of your income when you apply for an investment property mortgage.

Why you shouldn’t lie about occupancy type on your mortgage application

It’s not a good idea to misrepresent how you plan to live in or rent out your home on your loan application. You will not be the first person who has thought of ways to mislead lenders, and lenders will verify your property’s occupancy during and after the underwriting process.

In the past, lenders would hire people to go knock on doors to verify whether borrowers actually lived in the home. But these days lenders have more sophisticated and high-tech tools to verify occupancy. Lenders can use data analysis and algorithms to spot borrowers who may have lied on their mortgage applications. Data from credit bureau files, utility bills, and tax information can help determine whether your addresses are different than those used on loan applications.

Mortgage fraud comes with penalties

If you are found to have misrepresented your occupancy intentions on a mortgage application, then you could find yourself in hot water.

Misrepresentations on mortgage applications are deemed bank fraud, and subject to penalties, prosecution, and even prison time if convicted. If found out, your lender may call the loan due, which means you’d be required to repay the loan in full immediately. If you can’t afford repayment, the lender could choose to foreclose on the property. In extreme or egregious cases, lenders may also notify the Federal Bureau of Investigation (FBI).

Of course, there are some non-fraudulent situations where your primary home could turn into a future second home or investment property. And, you may find yourself in a situation, such as a job transfer, where you must buy a new primary home in a different neighborhood, city, or state, while you still own and live in your main home.

If you’re unsure of how your property will be classified or how it can affect your mortgage, then schedule a free consultation with one of our Mortgage Experts.

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