When applying for a mortgage, you can purchase three classifications of property: primary, secondary, and investment. The classification will affect the mortgage interest rate you will receive. Understanding each type of property classification will help you avoid higher interest rates and avoidable tax implications.

Primary Residence:

A primary residence is the main home where someone lives. It can be anything from an apartment to a houseboat, so as long as it’s where someone lives most of each year. You might not be surprised to find out that primary residences have the lowest interest rates of the three residence classifications. Documents such as tax returns, voter registration, and proof of employment near the property can usually verify an application for a primary residence. 

Once the mortgage is secured on a primary residence, the home must be occupied within 60 days. If the occupant is married, they must both claim the same property as their primary home. Suppose your loan originates from the VA and you are away on active duty. In that case, a spouse can satisfy the occupancy requirement. 

Itemized tax deductions for primary residences include mortgage insurance payments and mortgage interest up to $750,000. If the occupant plans on exiting the property within six months of closing, it must be classified as an investment.

Secondary Residence:

Second homes usually require higher credit scores than a primary residence, with higher interest rates to boot. After a lender reviews your financials, they will calculate your loan-to-value ratio (LTV), which may end up in a requirement of a large down payment for the secondary residence. 

To qualify for a Secondary Residence, you must plan on living in the home for some part of the year. It must be under your control and not subject to a renter. Other requirements usually include:

– 15-20% equity in your primary residence.
– Driving distance from your primary residence.
– Proof of on-time monthly mortgage payments.
– A substantial income history.
– Down payments tend to gravitate between 5% to 20% up-front.

Borrowers can rent out secondary residences for up to two weeks per year. The profitable income is allowed to be kept tax-free. In most cases, borrowers cannot rent out the secondary home for more than 180 days per year. However, all rental expenses during the 180 rented days are tax-deductible.

Investment Properties: 

Investment properties are homes you plan to use as a rental to generate income. These properties typically require a sizable down payment and have more LTV restrictions. Monthly mortgage payments on investment properties tend to be higher due to the lender’s more significant amount of risk. 

To secure an investment property, you must have strong credit and proof of previous on-time mortgage payments, and of course, liquid assets to spend. Borrowers must report all income on an investment property on their tax return. Still, borrowers can deduct expenses such as maintenance, interest, and taxes.

Conversions: 

Suppose you decide to convert an investment property or second home into a primary residence. In that case, you must complete a 1031 exchange, informing the IRS. It would be best to go through an experienced mortgage brokerage for advice and execution in this process.