Second Home or Investment Property Loan?

Question

So I'm considering buying a second home back in my hometown where my family lives. With my dogs and the costs of boarding/renting, it makes financial sense to just own a cheap home in a C or D-class area of another town. It's about 700 miles away and if I was there 2-3 weeks of the year, I'd pay less to own than board and rent.

What I'm wondering is how the qualifications differ between second-home and investment-property mortgages. It sounds like second-home has lower down payments and better interest rates, but if I realize that I decide in the future I want to AirBNB it or do seasonal rentals while I'm not there, does that immediately disqualify me from having the second-home? It's a house I'd be fine with owning even if it didn't make me a profit so I could see my family more often, but I guess I'm wondering the differences between loan type and what I am and I'm not allowed to do with the property.

Andrew Postell · Answer

@Lucas Hammer the rule is this cannot be a rental property.  So if the primary use of this property is to rent it, that would violate the terms of the loan.  If it is your 2nd home, that you vacation in or something like that, and you then rent it occasionally, that would not violate the terms.  But if you signed a property management agreement with a company that would find you renters, that would also violate the agreement.  So all of your renters would need to be self-sourced essentially. I hope that helps explain it a little better.

Andrew Postell · Answer

@Lucas Hammer there are some really specific requirements for a second homes within the Fannie/Freddie world and something called "OVERLAYS" (more on that in a moment).  Granted there are lots of other loans out there but if you want the absolute best rates and terms then Fannie/Freddie is the route to go.  Here's what you need to know (this was taken directly from the Fannie Mae selling guide):

The basic "Second Home" Requirements are:

• must be occupied by the borrower for some portion of the year
• is restricted to one-unit dwellings
• must be suitable for year-round occupancy
• the borrower must have exclusive control over the property
• must not be rental property or a timeshare arrangement
• cannot be subject to any agreements that give a management firm control over the occupancy of the property

***If the lender identifies rental income from the property, the loan is eligible for delivery as a second home as long as the income is not used for qualifying purposes, and all other requirements for second homes are met (including the occupancy requirement above).

So as long as you can fit the second home into those points above, you can acquire financing for a 2nd home.

HOWEVER (and this is a big however) there are these things called OVERLAYS.  Overlays are extra rules that lenders are allowed to put on top of Fannie/Freddie loans to make their lending more conservative.  It sounds weird but banks will place extra rules so that they lend less to what they deem "more risky" transactions.

Some common overlays:

• Loan minimum - there is no loan minimum according to Fannie/Freddie.  A bank will place this overlay because they don't make as much money on lower loan amounts.
• Credit Scores - 620 is the minimum to Fannie/Freddie....but many a bank will have 660 as their minimum.  This is a bank overlay
• RENTAL - And yes, a lender could very much require  you to sign an affidavit stating you won't rent this property.  It is entirely possible.

So the reason why we preach working with small banks is because smaller lenders have less overlays.  It might be hard to find a good small lender....they usually don't advertise, they usually only have a few locations, and they may only have a handful of loan officers.  But if you do find one, they are great to have in your pocket.

So if you can fit into the above items AND find a lender with no overlays concerning those items, you can get a loan for a 2nd home.

Hope this helps!

Lucas Hammer · Answer

Thanks @Jerry Padilla! That eases my mind quite a bit.

@Andrew Postell, I have a question on the **** section. Is that saying that you actually can rent it out, but the money can't be used as income for loan qualification purposes? I'm just trying to make sure I understand that since it seems to be a contradiction to the "must not be rental property." On that note, does it mean that it can't be a rental at the time of purchase or at any point during the loan?

Jerry Padilla · Answer

@Lucas Hammer

To answer your second question, you would never be forced to refinance to an investment property if you decide to rent out your primary residence or second home etc. Things happen in life, but a good rule of thumb to go by is 1 year of keeping the property your primary or second home, for whatever documents you sign at closing.

Melvin List · Answer

@Lucas Hammer I would agree with @Andrew Postell and think he is spot on with his advice.  I would also like to add that any experienced broker will be set up with lenders that have no overlays.

Lucas Hammer · Answer

@Melvin List Thanks. So if a few years down the line I decided to rent it out, I'd just refi into an investment/conventional without the second-home option?

Melvin List · Answer

@Lucas Hammer you will sign a rider on the mortgage/note stating you will not rent out the property when financing as a second home

Second Home or Investment Property Loan?

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