An investment property is a piece of real estate property whose intention is to generate income or profit.
What is an investment property?
An investment property is a property that serves as a means of getting a financial return for the owner. This financial return can be in the form of regular rental income, in the future resale of the property, or both.
Investment Property Versus Second Home
A second home is a residence that you live in, in addition to your primary home. For example, a second home could be a vacation home that you stay in regularly or that you stay in, while on business in another city.
One of the usual requirements is that the property is not under any timesharing arrangement or rented out when not in use. A second home is reserved for the borrower’s exclusive enjoyment.
On the other hand, an investment property generates income for the homeowner. This means that you rent out the property or allow a management firm to handle occupancy and use the property.
Difference Between Financing Your Primary Residence and an Investment Property
Borrowers are more likely to default on a home that they do not actually occupy. As a result, investment properties are riskier ventures than a mortgage for a primary residence. Banks make up for this risk by charging higher interest rates and requiring a more substantial down payment.
In general, investment property homes typically have higher interest rates, approximately 0.5 to 0.75 percent more, than a mortgage for your primary residence. Moreover, the interest rates are usually higher than second home mortgages as well.
Lenders usually have a lower loan-to-value ratio requirement for investment properties. In other words, you will likely need a higher down payment.
For example, for a one-unit investment property, the LTV ratio may be 85%. Therefore, for a $200,000 property, your down payment is $30,000 or 15%. For a two to four-unit investment property, the LTV ratio may be 75%, which means you will need a 25% down payment.
With a high down payment, you will likely also avoid mortgage insurance on your investment property.
Types of Loans
Most lenders will require liquid cash reserves equivalent to several months of mortgage payments in the bank. This is a precaution to make sure you can afford the monthly payments even if your property is unoccupied for a few months.
Most borrowers have a variety of financing options if securing a loan for their primary residences, such as FHA loans, VA loans, and convention loans. However, investment properties do not qualify for many types of loans.
In most cases, FHA and VA loans are granted to homebuyers who intend to live on the property as their primary residence. There are options for government-backed loans if you purchase a multi-unit and choose to live in one of the units. Be sure to check the property’s eligibility with your mortgage lender. However, in general, a loan for an investment property is usually restricted to a traditional mortgage or a home equity loan.