Earlier this month, the National Association of Realtors released their annual Investment and Vacation Home buyers Survey that collects data on existing and new-home sales. The report is always packed full of numbers and some of those numbers can be a bit overwhelming, as in “information overload” but there are definitely some nuggets to be found. Yet perhaps the biggest question to be asked is whether or not it’s a good time to buy a vacation home or an investment property? Is there anything in the report that can answer that question?
According to the association, there 717,000 vacation home transactions last year compared with 553,000 from the previous year while investment property sales actually fell from 1.21 million to 1.1 million last year. Vacation home sales up nearly 30 percent while investment properties fell 8.5 percent. But let’s first make sure we understand the differences between a vacation or second home compared with an investment home. Lenders certainly make that determination and it’s important to understand why.
The Difference between a Primary Residence, Second Home, & Investment Property
When mortgage lenders evaluate an application for a home loan they want to make sure they’re going to get paid back on time, every time. There are a variety of risk factors involved including credit and income and lenders also place a premium on occupancy. Owner-occupied properties carry less risk for the lender compared to non-owner-occupied homes. Why? It’s easy to see that when borrowers find themselves in financial straits and they own two homes, the one they live in and a rental unit, the rental unit will be the one let go first. After all, the owners need a place to live, right? That’s why mortgage rates for rental homes are higher compared to a primary residence.
Lenders also evaluate non owner-occupied properties differently as it relates to vacation homes and investment properties. A vacation home, or a second home, is considered less risk than a rental property and rates are adjusted accordingly. Most lenders don’t charge a premium for a vacation home and the rates will be similar to those for a primary residence. An investment property will carry such a premium and the interest rate on investment property can be as much as ¼ percent higher compared to a primary residence or a vacation home. How does the lender know if a property purchased will be a vacation home or investment property? The lender makes a common sense evaluation of the transaction because there won’t be a great big sign in the front yard proclaiming, “This Is a Vacation Home!”
The borrowers are asked to identify the property as a primary residence, a second home or an investment property and the lender starts from there. A vacation home or a second home needs to be located in an area that would make sense for a vacation home to be located. For example, if the property is on the beach, in the mountains or in a resort area, the lender will correctly assume the property is indeed a vacation home.
Vacation homes and second homes aren’t rented out during the year. If they are, they’re considered an investment property. Most lenders do make allowances for a property that is only rented out for no more than two weeks per year and not increase the mortgage rate. If the property is across town and a relatively short drive away, it’s probably not going to be the place where the family goes for Spring Break every year.
Is Now the Time to Buy a Vacation Home or Rental Property?
It’s interesting to note that vacation home sales rose while investment properties did not. That needs to be taken into context because home values plummeted to such depths that they were undervalued. Homes went into foreclosure at a rapid pace and investors found they could buy real estate that was priced under market. As real estate values began to stabilize in many areas and foreclosure filings waned, it’s understandable that fewer bargains mean fewer sales.
On the other hand, vacation and second homes jump was considerable as year over year sales jumped 29.7 percent. Vacation homes are non-revenue producing and the owners don’t collect any revenue. It’s an expense and the buyers need to be able to afford two mortgages if the property is financed and are usually associated with higher income earners.
Yet with either type of property it’s important to remember that mortgage rates, while not at their historic levels seen in January of 2013, are still very, very low and those that buy and finance a second home or investment property and lock in today’s rates will benefit for years to come. All real estate markets are local and there can’t be any real generalizations made but home prices have been on a gradual rise over the past few years and mortgage rates are still very attractive. If you’ve been thinking about buying a vacation home or a rental property, those two considerations alone should help make up your mind.