Consumer Vs. Investment Property Mortgages
Buying a second home is a popular choice for many people. Second homes can provide investment opportunities, as well as a place to save for retirement or other purposes. Since lenders and tax entities look at second homes and investment properties differently, it’s important for borrowers to understand the distinctions between them. Here are a few things that you should know before you make a choice.
Getting a Mortgage as a Consumer vs. Investor
When you apply for a mortgage to buy a home, you’ll apply as a resident or investor. The type of loan you can get depends on this choice, and it plays a role in other factors as well. A consumer mortgage is a loan given to a borrower who plans to live in the property at least part-time and repay the mortgage with income earned from a job or other investments. An investment property mortgage is a loan disbursed to an investor who does not plan to live in the unit but intends to earn money from it. Here are several comparisons of the buying process for consumers and investors.
The difference between an investment property and a second home is occupancy. If you live in the home for more than 14 days (or rent it out 10% of the time or less), it may not be considered a rental property for tax purposes. By comparison, if you live in it for less than 14 days per year and you do rent it out, it may count as a rental property when you do your taxes. This distinction determines which deductions you can make on your taxes.
Down payments for residences tend to be lower, since people are less likely to default on payment for a personal residence. If you buy a home to live in, your down payment could be 10% or lower. Investment properties usually require a 20% down payment, but it could be higher.
Qualifying for a mortgage depends on the income you have as a consumer, or the revenue you expect as an investor. Lenders want to be sure that you can get the rental income you need to pay the mortgage and other expenses. For a fix and flip borrower loan, qualifying might depend on the estimated post-renovation value of the home.
A consumer’s ability to get a mortgage also depends on his or her existing debts in relation to available income, including the cost of the mortgage. For an investor, lenders may look at the debt service coverage ratio. This ratio shows how much in rental income the investor has to cover expenses after the mortgage is paid. The lower the ratio, the less money the investor has each month.
The type of appraisal depends on the purpose of the investment property. A fix and flip investor may get an appraisal that is fairly similar to an appraisal for a consumer home, which establishes fair market value based on comparable homes. A rental home investor may need an appraisal that establishes fair market value and average rent, which can increase in complication for multi-family homes.
Traditional loans are popular for consumers, largely because they provide a number of consumer protections and benefits, such as a lower down payment. Investors can apply for traditional, government-backed or conforming mortgages in many cases. They can also consider other types of lending, such as asset-based or private lending. These lenders may offer loans with competitive benefits that appeal specifically to investors, such as quick processing and customized loan options.
The closing process can be significantly different for an investor than a consumer, depending on the loan type. For investors, some loans can take weeks to conclude the sale, while others might only take a week or two.
The road to real estate investment often starts by buying a second home. With this information, you’ll understand the basic differences between buying a home as a consumer and getting a mortgage as an investor.