Do you have extra funds to invest in another property but can’t decide between a vacation home or an investment property? Can they be one and the same?
Yes- they can, but there are differences. As someone who has owned both, I’ll explore both options to help you make the best choice.
Whether you seek a cozy retreat or a profitable venture, I’ll guide you through the intricacies of vacation homes versus investment properties. Let’s dive in and discover which option suits your needs best!
TL;DR
- Vacation homes are for personal use and leisure, often located away from your primary residence.
- Real estate investment properties are purchased for financial returns.
What is a Vacation Home?
A vacation home is a property you own and use primarily for recreational purposes, such as taking vacations or getting away from your daily routine.
It is typically located in a different area than where you live such as near a beach, in the mountains, or a popular tourist destination. It is where you can relax, have fun, and spend time with family and friends.
What is an Investment Property?
An investment property is a type of real estate purchased to make a financial return. Instead of buying a property for personal use, like a home to live in, an investment property is purchased to generate income or increase in value over time.
Vacation Home Vs Investment Property
What are the differences between vacation homes and investment properties? Here are the factors:
Interest Rates:
Vacation Homes: Interest rates for vacation homes can be slightly higher than those for your primary residence because the bank considers them a bit riskier. Reasons are due to less frequent use, financial prioritization, market volatility, and location factors.
Investment Properties: The interest rates can be even higher when dealing with investment properties because banks view them as business deals. You’re buying the property to make money, and that can be riskier, so they might ask for a bit more money in interest.
Down Payment Requirements:
Vacation Homes: You need to pay a down payment when you’re looking to buy a vacation home, just like you did for your first home. Down payments for vacation homes are often higher, around 10% to 20% of the home’s price. For a $200,000 vacation home, you should expect to pay $20,000 to $40,000 upfront.
Investment Properties: If you’re eyeing an investment property, be prepared to bring even more money. The down payment requirements for investment properties can be higher, sometimes around 20% to 30%. For a $200,000 investment property, you might need $40,000 to $60,000 as a down payment.
Financing Requirements:
Vacation Homes: When you want a loan to buy a vacation home, the mortgage lender wants to make sure you can afford it. They also want to see that you won’t rent it out most of the time because it’s meant for your enjoyment. They might ask you questions about your income and plans for the home.
Investment Properties: Be ready for stricter rules if you plan to buy an investment property. Lenders are more cautious because you are buying the property to make money from renting it out. They might require higher credit scores and more proof that you can handle the property from a business perspective. They might want to see your business plan before they lend you the money.
You should also contact lenders to see if your property will qualify for for a DSCR loan. This type of loan looks at the income from the property versus your personal income.
Cost and Expenses
Vacation Homes: You’ll pay for expenses such as the monthly mortgage payment, property taxes, insurance, and any maintenance or repairs when you own a vacation home. It’s like taking care of your regular home.
Another thing is you might not be there all the time, so you might also need someone to look after the place when you’re not around. That’s an extra cost.
Investment Properties: You have similar costs like investment property mortgage, taxes, insurance, and repairs. There are even more expenses since you are rentint it out to make money.
You might need to pay for advertising to find tenants, property management, and legal documents like leases. It’s like running a small business.
Here are some of the things I have paid for in my rental business that you typically won’t have with a personal use-only vacation home:
- Phone services to answer potential tenant questions and enable voice messaging separate from my personal cell.
- Advertising on various rental sites.
- Tenant turnover costs like cleaning and repairs every time a tenant moves out.
- Tenant screening software.
- Property management software to collect rents.
- Legal fees for eviction and other situations.
- Taxes on rental income.
Tax Implications:
Vacation Homes: There are some tax benefits when you have a vacation home. You can deduct some of the mortgage interest and property taxes you pay. It can lower your overall taxes. But there’s a limit to how much you can deduct, which might be smaller than you hope.😲
Investment Properties: Investment properties come with more tax benefits. You can deduct many expenses, like repairs, insurance, and even the interest on your loan. You can also claim depreciation, like a tax deduction for the wear and tear on your rental property. However, you’ll have to pay taxes on your rental income.
Credit Score Requirements:
Vacation Homes: You’ll need a decent credit score for vacation homes, usually around 620 or higher. The better your credit score, the easier it is to get a loan for your vacation home.
Investment Properties: The rules for investment property loan are more challenging. You might need a higher credit score, often around 720 or more. Mortgage lenders want to be extra sure you’re good with money since investment properties are seen as riskier.
These factors can affect your decision when choosing between a vacation home and an investment property. Think about your financial situation and goals before making a choice.
Vacation Homes: Advantages and Disadvantages
A vacation home can be a dream come true, but comes with responsibilities and costs.
Let’s explore the benefits and challenges to help you make a good choice.
Advantages:
- Personal Getaway: Your vacation home can be your special place to escape whenever you need a break and have your retreat.
- Familiarity: You already know the area and feel comfortable there. It’s like a second home where you know the neighbors and the best local spots.
- Flexible Use: You can enjoy your vacation home whenever you want. No need to book or worry about availability.
- Potential Rental Income: You can rent it out to earn extra money when you’re not using it. It’s like your vacation property helping to pay for itself.
Disadvantages:
- Upfront Costs: Buying a vacation home can be expensive. You’ll need a down payment and be ready for ongoing expenses.
- Maintenance: Your vacation home needs upkeep, just like your primary home. Repairs, cleaning, and other maintenance costs can add up.
- Location Limitations: Your vacation home is in one fixed place. You might have better choices if you want variety in your getaways.
- Potential for Overuse: You might feel obligated to use it often when you have a vacation home, even when you want to explore other destinations.
Vacation homes offer a personal escape and potential for rental income. However, they come with costs and responsibilities, and you might find them limiting if you love exploring new places. Weigh these advantages and disadvantages to decide if a vacation home is the right fit for you.
Investment Properties: Advantages and Disadvantages
Investment properties can be a source of income but also bring challenges and commitments. Here are some of the advantages and disadvantages to help you decide if owning an investment property is right for you:
Advantages:
- Rental Income: Investment properties can bring in rental income every month. It can be like having a money-making machine.
- Property Value Increase: Your property’s value might appreciate over time, providing a way to build wealth.
- Tax Benefits: You can often deduct expenses, pay less in taxes, and get some of your money back.
- Diverse Portfolio: Owning investment properties can be a smart way to expand your investments. You can have different types of investments to spread the risk.
Disadvantages:
- High Upfront Costs: Buying an investment property can be costly. You’ll need a substantial down payment and be prepared for ongoing expenses.
- Tenant Management: Dealing with tenants can be challenging. You might have to find good renters, handle problems, and deal with late payments.
- Property Maintenance: Investment properties need regular maintenance and repairs, just like your main home, which can be an added expense.
- Risky Market: The real estate market can go up and down. If property values drop, you might earn less money than you expect.
Investment properties can provide a steady income and tax benefits. However, they also require significant upfront costs, tenants, and property management and come with market risks. Consider these advantages and disadvantages to decide if owning an investment property aligns with your financial goals.
Should You Buy a Vacation Home or an Investment Property?
It depends on your goals and what you want, whether to buy either an investment property or a vacation home. Here’s a simple way to think about it:
Buy a Vacation Home if:
- You want a special place for vacations and getaways.
- You’re comfortable paying for and maintaining it, even if you don’t use it often.
- The idea of renting it out sometimes for extra cash sounds good.
Buy an Investment Property if:
- You want to make money from renting out a property.
- You’re ready to manage tenants and the property like a small business.
- You’re prepared for higher upfront costs and possible market ups and downs.
Think about what you want, which will help you decide whether to go for a vacation home or an investment property.
Conclusion
Deciding between a vacation home vs investment property is both exciting and challenging. As someone who has experienced both, I’m here to provide guidance for your unique situation.
I’ve shared how a vacation home offers personal solace and potential rental income, while an investment property can be a source of regular rental income and long-term wealth, with distinct responsibilities.
I also explored interest rates, down payments, financing, costs, and my property management cost categories. Your choice hinges on your goals.
Seek a vacation home if you want a personal sanctuary and potential income. Consider an investment property if you’re ready for tenant management and market fluctuations.
Decide based on your financial objectives and lifestyle. Take time to evaluate your goals and make the choice that suits you best.
Second Home vs. Investment Property FAQs
Can you claim your investment property as a vacation home?
Yes, you can claim your investment property as a vacation home. The property must be used for personal purposes for a certain amount of time each year to qualify as a vacation home. You need to use the property for at least 14 days or 10% of the total days it is rented out, whichever is longer.
What is the 2% rule for investment property?
The 2% rule for investment property is a guideline that suggests the monthly rent you collect should be at least 2% of the property’s purchase price. For example, if you buy a property for $100,000, the monthly rent should be around $2,000.
What is the 50% rule for investment property?
The “50% rule” estimates that approximately 50% of a rental property’s income will cover operational expenses and maintenance. It’s a quick way to assess potential profitability. Actual expenses can vary by property type and location, so gather detailed data for accuracy.
Is a vacation home considered investment property by the IRS?
No, a vacation home is usually not considered an investment property by the IRS unless you rent it out.
Nic
Nic is an avid real estate investor who partners with her husband on hotel syndications. Prior to hotels, she owned apartment complexes and single-family homes. Her insider expertise makes her the ideal resource for those seeking to grow their income via property investments.
