There are key differences between investment property and a second home. Many assume that buying another house for investment purposes is just like purchasing a vacation property for the family. This can lead to a lot of frustration as the process will not meet their expectations. Understanding the differences helps to make the process of moving from personal to investment purchases a bit easier.
A major area of difference is home financing. Each type of property has distinct qualification standards. You may qualify for a second home but not for an investment property. This is caused by the higher risks involved in rentals and investment value. Market conditions, unknown tenants, and other factors cause lenders to see a greater chance of financial problems. Understanding the distinction between lending criteria and why differences exist will help you get through the investment process with less stress.
Investment Properties and Personal Use Homes
Down Payments:
A larger down payment and/or more collateral are required to finance a second home, compared to your primary house. While a loan for your first home may only require a 5 to 10 percent down payment, additional properties may need as much as 25% down. Lenders will usually require more collateral, larger down payment or shorter loan period for investment properties. Remember, the lender is attempting to balance the risks with the potential income from interest.
Interest Rates:
Interest rates usually rise for second and third properties. This is also true for leased and rental properties. Statistically, homeowners with additional property are more likely to default on at least one loan. In addition, properties which are leased or rented out can be subject to a lot of wear, tear, and damage from the temporary residents. The higher interest rate ensures a faster return on the loan for the lender, insulating them from these risks.
Homeowner’s Insurance:
Homeowner’s insurance almost always rises for secondary properties, whether for personal use or investment purposes. With personal use, such as vacation homes, the properties are left unattended and vacant for periods of time. This raises the risk of theft, unnoticed problems, and insufficient property maintenance. For investment properties, there are liability risks and a higher chance of property damage.
Other Factors
There are a few other things unique to rental and investment property that you should keep in mind:
1.A common requirement is the escrow of three months of financial obligations. This includes insurance premiums, loan payments, and taxes.
2.Only 50% to 75% of the expected lease or rental income will be taken into account when applying for a loan. You need to be able to show that you can cover a quarter to one-half of the expected payment without rental income. Documentation supporting the projected income is expected. The best way to get it is to ask the seller about their rental income from the property.
3.If there are no current occupants, the lender may require that you have a qualified lessee or renter lined up for the property. This helps reduce the risk of a loss on vacant property.
There may be other factors considered by the bank or lender for investment properties. However, a good credit rating, reliable income, and substantial down payment are universally required
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