Buying investment property can mean many things. Sometimes people even use this phrase to describe buying a home they live in because, after all, that property is a big investment for them.
But investment property most commonly means buying a home that you don’t live in, but instead rent out. Let’s take a look at the key things you need to know about buying and financing investment property.
Intro to Investment Property Mortgages
When you buy an investment property, you need an investment property mortgage. The first thing to know is what other names these mortgages go by, so you know them when you hear them.
A lot of consumers and real estate agents will call this kind of loan a rental property mortgage.
Lenders, on the other hand, will call this a non-owner occupied mortgage.
The reason for this is that lenders categorize loans by the occupancy, and there are three kinds of home loans:
- Owner-occupied mortgages: These loans are for people buying a home they intend to live in as their primary residence. These loans require you to move into the home within 60 days of closing the loan, and you must live there for at least one year — after that, you’re free to rent out the home, and your loan terms can’t change.
- Second-home mortgages: These loans are strictly for people buying a home they intend to use as a second home for family and friends, and lenders prohibit rental of the home. If you rent your home with a second-home mortgage on it, that mortgage can be called due and payable all in one lump sum.
- Non-owner occupied mortgages: These loans are for people who want to rent out the home. If at any time you want to convert this rental home to a primary residence, you’re free to do so, and it won’t change the terms of the loan.
Investment Property Mortgage Rates
If the non-owner occupied mortgages above sound flexible—in that you can convert the home from a rental to a primary residence if you wish—that’s because the rates for these loans are higher, and so are the down payments.
The risk to the lender actually goes down if you were to convert a rental property to a primary residence.
How much higher are rates for investment property mortgages? Rates are about .25 percent to .75 percent higher for these loans than for an owner-occupied mortgage, and you’ll be at the lower end of this range if your down payment is larger.
The least you can put down on an investment property loan is 20 percent, but you won’t see the best-available rates until you increase your down payment to 30 percent or more.
Want to talk to a lender about investment property mortgages? Find a lender on Zillow
Tax Treatment for Investment Property Mortgages
If you have a rental property, this will show up in a section called Schedule E of your tax returns, which shows all the income and expenses of your rental property.
Expenses include mortgage interest, as well as many other things like property taxes, insurance, HOA dues (if it’s a condo), maintenance fees, rental management fees, and depreciation.
If the net number on Schedule E is positive, that number counts as income, and you’re taxed on it.
If the net number is negative, that number counts as a loss, and reduces your taxable income. But there’s a catch here because higher earners don’t always get the benefit of reduced taxable income each year. If you make too much, a rental property loss on Schedule E would instead accrue yearly and count as an offset to capital gains when you sell the rental property.
Talk to your tax advisor for advice on which scenario would fit your profile.
Things to Watch Out for When Financing a Rental Property
People often assume they can rent their second home when they’re not using it. This is false, and can land you in trouble. It’s critical to understand why you can’t ever rent out a property you financed with a second-home mortgage.
The reason this isn’t allowed is because of how the IRS treats taxes for second homes. If you own a second home, the mortgage interest and property taxes on that second home are fully deductible (on Schedule A) just like mortgage interest and property taxes for a primary residence.
Knowing this, it makes more sense that lenders don’t allow you to rent out a property with a second-home mortgage on it, because you’d be double dipping by getting rental income and also getting the same tax benefit as you do with a primary residence.
If you want to have a second home that you can also rent out, then you need to finance it with a rental property mortgage to comply with lender and IRS rules. This means you’ll need a larger down payment, and will pay a slightly higher rate, but you will benefit from the income — and you can also use the income to qualify for the loan.
Interested in buying an investment property? Find a local lender on Zillow who can help.
Best Mortgage Rates for Investment Properties
Posted by: us.dujuz.com