Investment properties and vacation homes might seem like similar concepts — after all, they're both great ways to grow wealth and expand your real estate portfolio. But did you know these two terms have significantly different meanings? The distinction is actually pretty important when it comes to financing, and it really comes down to how you intend to use the property. If you've been thinking about purchasing an investment property, here is what you need to know:
What Is An Investment Property?
An investment property is a property that you purchase with the intent of generating income. In most cases, this means serving as a landlord and renting the property out to tenants. In other words, an investment property may be a business, while a "vacation home" or "second home" is another property away from your primary residence that you use for visiting or living in part-time.
While it's certainly possible to purchase a vacation home that you occasionally rent out, it's important to define the home's primary purpose when seeking financing. Trying to pass an investment property off as a vacation home for the purposes of achieving better mortgage rates can lead to severe legal consequences.
What To Look For In An Investment Property
While a second home or vacation home is often selected based on location and amenities, an investment property should be evaluated on the potential to generate a return. As a result, you'll want to consider features that can help you achieve higher rental income, such as size, parking, amenities, crime, and public transportation. Look into average rent for similar-sized properties within the same area to get a sense of how much you'll be able to charge. You'll need to have a solid business plan when applying for a mortgage on the investment property.
How To Finance An Investment Property
Financing an investment property is a bit more complicated than securing a mortgage on a primary residence or second home. For one, lenders typically require a higher down payment (at least 20%) for an investment property, and there isn't much flexibility here.
Also, because you're going to be making a profit on the property and because the transaction is much riskier, lenders won't hesitate to charge significantly higher fees and interest rates. Your lender also may require that the investment property be located within a certain distance of your primary home.
Tax Implications Of An Investment Property
Owners of primary residences and vacation homes can deduct mortgage interest from their taxes, and investment property owners can do the same. However, investment property owners have the added advantage of being able to deduct many other expenses associated with the property as they technically qualify as business expenses. However, your rental income will also need to be reported too.
Investing in real estate is a great tool for securing long-term financial stability. While financing is a bit more expensive than a vacation home, you also stand to make a larger profit if you're purely operating the property as a rental.