What Is the Difference Between an Investment Property and a Second Home?

Learn the difference between a second home vs. investment property, and find out how it can affect the type of loan you can get.

By , Attorney · University of Denver Sturm College of Law

People sometimes interchange the terms "investment property" and "second home" when describing real property that isn't their primary residence. However, these types of properties are different.

An investment property is a property you buy to generate income like to rent to tenants or flip and sell for a profit. However, a second home is a single-family dwelling you plan to live in for some of the year or visit regularly.

What Is an Investment Property?

The definition of an "investment property" is a property that's:

  • not your primary residence, and
  • is purchased or used to generate income, profit from appreciation, or take advantage of certain tax benefits.

What Is an Example of an Investment Property?

Examples of investment properties include:

  • residential rental properties
  • commercial properties, and
  • properties purchased to flip (resell for a profit).

What Is a Second Home?

A "second home" is a residence you intend to occupy for part of the year in addition to a primary residence.

To get a mortgage loan to buy a second home, the property typically must be located in a resort or vacation area, like the mountains or near the ocean, or a certain distance (typically at least 50 miles) from the borrower's primary residence. Also, the borrower must meet credit and other underwriting requirements,

What Is an Example of a Second Home?

Usually, a second home is used as a vacation home. But it could also be a property you regularly visit, such as a condo in a city where you often conduct business or a pied-à-terre.

What Are the Similarities Between Investment Properties and Second Homes?

Investment properties and second homes are similar because they are both types of property you don't use as a primary residence. However, with both, you're responsible for property maintenance, repairs, property taxes, insurance, and utility bills.

Either type of property might appreciate in value over time, and owners of both investment properties and second homes might qualify for certain tax deductions or advantages (see below).

Mortgage loans are available for qualified borrowers to buy an investment property or second home. But the terms and interest rates vary from lender to lender and in different situations, like if you have bador good—credit.

What Are the Differences Between Investment Properties and Second Homes?

Basically, if you buy real estate that you'll use just to make a profit rather than as a personal residence for you and your family to visit at times, that property is considered an investment property. Second homes are used for personal enjoyment.

What Factors Should I Consider When Deciding Between an Investment Property and a Second Home?

First, consider what you want to do with the property: make money or have fun with it. Secondly, if you'll be taking out a loan to buy the property, consider the loan requirements and terms and how they'll affect your financial situation. Investment property loans usually have higher interest rates and require a larger down payment, typically around 20%, than properties people use as second homes. On the other hand, second home loans regularly have a lower interest rate than investment property loans.

Also, be sure to pick the right location, considering the rental market (if applicable) or whether the property is in a desirable vacation spot. Finally, take a close look at the associated costs of buying and maintaining a property, including mortgage payments, property taxes, homeowners' insurance, and potential income. That way, you can determine if buying a property and which type is a good idea.

Which Is Better for Me: An Investment Property or a Second Home?

A second home loan might be appropriate if you want to use the property yourself, but perhaps rent it out sometimes or keep it for your exclusive use. An investment property loan is probably appropriate if you want to rent the property out full-time.

If you're considering taking out a loan to purchase an investment property or a second home, understand the differences between these terms and make your intentions clear to the lender when you apply for the loan. That way, you'll ensure you get the correct type of loan for the property you intend to buy.

Don't be tempted to buy a property as a second home when you intend to use it as an investment property to avoid a higher interest rate and stricter loan qualification requirements. This tactic is considered mortgage fraud.

How Do I Finance an Investment Property or Second Home?

When it comes to financing, it's more straightforward and less expensive to get a mortgage for a primary residence. After all, in tough financial times, people prioritize paying for their main home.

So, lending requirements are stricter for second home and investment property loans than principal residences. Both second home and investment property mortgages require better credit scores and a larger down payment than a primary residence loan. You might have to show that you have enough savings, called "reserves," to make the payments for up to six months.

You'll probably also need sufficient income to cover two mortgage payments (your primary residence and the second home or investment property). Generally, you can't use the rental income you expect to receive from an investment property to qualify unless your tax returns show you have property management experience, subject to some exceptions. Talk to a mortgage lender to learn more.

Getting a second home mortgage is generally cheaper and easier than a loan for an investment property. Investment properties are typically the most difficult to finance.

Can I Rent Out My Second Home?

Eventually, you might want to convert your second home into an investment property. Read your mortgage documents carefully to determine if the contract restricts whether the second home can be rented or how long the home must be used as a second home.

Second Home Riders

A second home loan might include a Fannie Mae/Freddie Mac "Second Home Rider" with the mortgage. This rider often says that:

  • the borrower will occupy and use the property as the borrower's second home
  • the borrower will maintain exclusive control over the occupancy of the property
  • the property can't be subject to any timesharing arrangement or rental pool, and
  • the property can't be subject to any agreements that require the borrower to rent the property or give a management firm (or any other person) control over the occupancy and use of the property.

So, this rider makes it seem like you can't rent out a second home. But Fannie Mae and Freddie Mac rewrote their guidelines to clarify that if you have a Fannie Mae or Freddie Mac mortgage on a second home, that house can be used as a rental property, subject to some limitations.

Rules for Renting Out a Second Home If You Have a Fannie Mae/Freddie Mac Second Home Rider

Here are the rules:

  • During the first 12 months, short-term renting is allowed. But you must keep the property available primarily as a residence for your own personal use and enjoyment.
  • After you've owned the property for a year, you can do longer rentals.

Renting a second home was always allowed for Fannie Mae and Freddie Mac policies under certain circumstances. But because of the complex language in the rider, both borrowers and lenders often didn't understand the rules.

How Do I Manage an Investment Property or Second Home?

If you have a second home rider like the one discussed above, you can't use a property management company to help you manage renting your second home. So, if you find yourself in this situation, you must handle all rental tasks associated with your second home (if you decide to rent it out), such as finding renters, collecting payment, and maintaining the property. You can hire someone to do particular tasks like yard work, but you must manage the rental yourself. You also can't enter into a timeshare agreement.

Managing any property, even just a second home you use exclusively yourself, but especially investment property, can be time-consuming. You might have to deal with difficult neighbors, numerous repairs, or an unexpected vacancy, all of which can impact your profitability and enjoyment. If allowed, you might consider hiring a management company to help you.

What Are the Risks of Owning an Investment Property or a Second Home?

Purchasing an investment property or a second home come with certain risks. Again, they usually require a substantial down payment, which will deplete your financial resources. In addition, maintaining another property can put a strain on your finances. You'll have to pay mortgage payments, property taxes, insurance, and maintenance costs. If you fail to make the payments, you could face a foreclosure as you would with your primary residence if you defaulted on the mortgage.

Also, the value of the property you buy might to up or down, depending on the real estate market. You might have to take a loss in the property's value or accept less in rental income.

What Are the Tax Implications of Owning an Investment Property or Second Home?

Investment properties and second homes have different tax benefits. For example, expenses usually aren't deductible for personal residences, like second homes. Associated costs with these properties are nondeductible personal expenses. But if you have an investment property, say a rental, you can write off expenses, like maintenance costs.

For tax purposes, if you rent out your property, including a second home, for 14 days or fewer each year, the income isn't usually taxable at the federal level. But if you rent out your property for more than 14 days per year, you'll have to pay federal income tax on your net rental income. (However, the terms of your mortgage contract might prohibit renting out a second home.)

Mortgage interest is deductible for a second home in some cases. For an investment property, it can be deducted as a business expense to lower taxable income.

Consult with a tax professional for comprehensive advice about taxation issues related to a second home or an investment property.

Getting More Information

To learn more about purchasing an investment property or second home, see Nolo's articles:

Talk to a real estate lawyer for more information about buying an investment property or a second home and how to finance such a purchase. If you have questions about the taxation of these properties, talk to a tax lawyer.

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