When you buy a new home, who lives there will help determine how much your mortgage will cost.
Most folks will buy a home they intend to live in themselves—we call this a “principal residence.” If you’re buying this kind of home, you’ll pay less for your mortgage than you would if you were buying an investment property—a home you plan to rent out. Basically, because different types of homes carry different risks for your lender, you pay more for homes you won’t live in full-time.
And while it’s true that loans for investment properties and second homes cost more, it’s best to be honest about your intentions for the property. If you claim you’ll live in your property full-time but your lender finds out you’ve been dishonest, you face steep consequences with lasting impact to your finances.
Knowing what to expect based on your use of the property will help you plan for realistic costs each month, and will help ensure you and your lender are on the same page.
Check out our resources below to learn more about occupancy and how it affects your mortgage:
- Why does occupancy matter for my mortgage?
- When is a property considered a second home?
- When is a property considered an investment property?
- How does my lender know whether I occupy the property or not?
- Is my co-borrower required to live in the property?
- How do I prove that my property is my principal residence?
- Can I claim the property as my principal residence or second home, then rent it out anyway?
Why does occupancy matter for my mortgage?
When it comes to your mortgage, occupancy matters because different types of homes carry different levels of risk for lenders.
“Occupancy” refers to how you’ll use the property—whether you’ll live there full-time, part-time, or not at all. Your occupancy has a big impact on your mortgage, affecting both upfront and long-term costs.
A principal residence—a home that you own and live in full-time—will cost less than a second home or an investment property. Because you live in and rely on this home year-round, you’re far less likely to miss payments or risk default on your mortgage. This mortgage carries less risk for the lender, so it’s more affordable for you.
If you’re looking to buy a second home, the risk assessment is different. Lenders know that, if you fall on hard times and need to miss a payment or two, you’ll pay the mortgage on your principal residence first, and are more likely miss payments on your second home.
Default rates are higher on second homes and investment properties, meaning that vacation homes and rental properties are riskier for lenders than a principal residence would be. To make up for this increased risk, lenders require larger down payments and charge higher interest rates for mortgages on second homes and investment properties.
If you compare down payment rates between these different occupancy types, the difference can be surprising:
- The minimum down payment for a single-family home serving as a primary residence is only 3%.
- Purchasing the same property as a second home would require at least 10% down.
- Purchasing the home as an investment property would require at least 15% down.
And it’s not just the down payment amount that changes the cost of your mortgage. A principal residence costs less over time, too. Because principal residences come with lower interest rates, you’ll pay less each month in both principal and interest, meaning you pay less for your loan over time.
When is a property considered a second home?
A second home is a property you’ll live in for more than half of the year. In order to be considered a second home by your lender, your property must be either a single-family home, condo, or townhome, and must be available for personal use for more than six months each year. Multi-family homes cannot be purchased or refinanced as a second home, even if you plan to live in one of the units for part of the year.
Vacation homes are some of the most common second-home purchases we see here at NewCastle. Lots of our Chicago-based borrowers, for example, buy lake houses in Michigan or condos in Florida where they spend summer weekends and holidays. Some of these borrowers even list their homes with companies like Airbnb, renting out the property for short-term stays when they’re not in town.
These short-term occupancies are perfectly acceptable for second homes. As long as you don’t have a long-term lease agreement with a tenant, use the property as a timeshare, or grant a rental agency control over the property and its occupancy, mortgage lenders consider the property a second home.
But just like there are specific rules for the occupancy of a second home, there are also specific restrictions and allowances for anyone looking to purchase a second home.
You cannot, for instance, use rental income that will be generated by the second home to help you qualify for your loan. Instead, you will need to qualify for the loan outright, proving that you can afford both the housing payment for the second home and the housing payment from your principal residence. Keep in mind, too, that your lender considers your housing payment to be the total cost of your loan payments—both principal and interest—property taxes, and homeowner’s insurance, on top of your mortgage insurance and association dues, if applicable.
Though it might seem contradictory given the name, you don’t even need to own a principal residence in order to own a second home. If you’re renting a condo but want to buy a vacation place for next summer, your lender will use your monthly rent payment as a debt when qualifying you for the mortgage.
Take, for example, Monica who bought a condo in Pigeon Forge, Tennessee for $295,000. She made a down payment of 10% or $29,500 and borrowed $265,500 from NewCastle Home Loans. She plans to live there half the year and hopes to rent it out via Vrbo when it’s otherwise not in use. She rents an apartment in Chicago that she still calls home.
Since Monica will live at her condo at least six months out of the year, and will host short-term vacation stays rather than a long-term lease, she can safely classify the condo as a second home when applying for the mortgage. By calling it a second home she avoided the higher loan costs and possible consequences with her lender.
To qualify for her mortgage on a second home, both housing payments will be factored in: her current rent payment for her principal residence and her future payment on the second home. This will be added to her other monthly debts, like student loan payments.
In Monica's case, she pays $1,100 per month in rent for her apartment in Chicago. The housing payment for the second home in Pigeon Forge is $1,475. She pays $115 per month for other debts. Her monthly income is $6,250.
We used these numbers to determine her debt-to-income ratio:
Rent payment - Principal residence
Housing payment - Second home
Other debts - Student Loan Payment
Total monthly debts
$2,475 / $6,250 = 44%
Monica can qualify for the mortgage with both housing payments factored in because she makes enough money to cover her total monthly debts.
While she can afford both payments on her own, Monica estimates she’ll make $3,000 per month by renting her second home. If she rents it out for half the year, she’ll bring in $18,000 to help with housing costs.
This $18,000 in short-term rental income will nearly cover the total cost of the home for the year. She’ll be able to enjoy her vacation condo for the other half of the year with minimal additional cost!
When is a property considered an investment property?
In the mortgage industry, an investment property is a home that a borrower purchases, but does not intend to occupy. Whether it’s a single-family home, a duplex, a 4-flat, or a condo, a home is classified as an investment property when the owner does not reside at the property.
Because investment properties are just that—investments—they carry even more risks for lenders than second homes. When you own an investment property, it’s possible that you’ll have a hard time finding tenants, or that you’ll face unexpected repairs that drive up costs and cause you to miss your loan payments. Increasing the risks for interrupted income from the property also increases the potential cost for your lender.
Given these additional risks, an investment property requires an even bigger down payment to purchase, and it carries a higher interest rate when compared to a primary residence or second home:
- A down payment of 15% is required for an investment property when it is a single family home, including a condo or townhome. In other words, you can borrow up to 85% of the property value.
- A down payment of 25% is required for 3- or 4-unit investment properties. You can borrow up to 75% of the property value.
- You can’t use gifted funds, or a gift of equity or grants as part of your down payment for an investment property. You must prove that you have the cash-to-close on hand in order for your lender to approve the loan.
You can, however, use your expected rental income from an investment property to help you qualify for the mortgage - depending on the circumstances. This is one of the primary benefits of an investment property: you’re able to offset your mortgage costs based on the income you expect to bring in from renting the home.
For more on this topic, check out our resources explaining future rental income.
How does my lender know whether I occupy the property or not?
The underwriter, who works for your lender, will evaluate your application materials and documents according to the lender’s guidelines, then decide whether to grant your loan or not. Ultimately, the choice to approve or not approve your loan is based on your stated purpose for the property and these gathered materials.
At the end of the day, the lender can’t know for sure whether you’ll rent out your property when you claimed it as your principal residence. But, chances are, they’ve developed systems that prevent borrowers from successfully deceiving a lender.
The underwriter will, for example, consider whether the stated occupancy makes sense given the information in your loan file. If you tried to purchase a vacation home that's only three miles from your principal residence, the underwriter will likely suspect you’re misrepresenting your intentions for the property. The vacation home would have to be located in an area appropriate for your second home—farther away, in a popular destination, for example—to be considered by the underwriter.
That said, there are always exceptions to the rule. If you’re worried the underwriter for your loan might not understand your situation, provide the lender with a signed letter explaining how you’ll use the property. With a signed statement in-hand describing your intended occupancy, they could be more willing to underwrite your loan.
Is my co-borrower required to live in the property?
Only one person applying for the mortgage needs to live in the property for it to be considered a principal residence. In order to help you qualify for the home, you may add someone else to the mortgage application, but this co-borrower doesn’t need to live in your home for it to be considered your principal residence.
Think of it like this: In some cases—particularly with younger borrowers—you might be ready to buy your own home before you can fully qualify for the loan with your own income. Adding other borrowers, like your parents, to your loan application can help you qualify for the mortgage you need. Their income combined with your own means that the three of you together easily qualify for the loan. But that doesn’t mean your parents have to live with you in order for you to ultimately receive the mortgage.
For the lender’s purposes, your parents would be considered non-occupant co-borrowers. Their names and information are used to qualify you for the loan, but not to determine your occupancy status. As long as you live in the home and call it your primary residence, you can take advantage of the low down-payment options, low interest rates, and low payments available for a principal residence.
How do I prove that my property is my principal residence?
To avoid any risks associated with misrepresenting your occupancy, make sure the information you give your lender is true and accurate. When you’ve been approved for your loan and are gearing up to move, update your address with your bank, your employer’s human resources department, your utility companies, the USPS, and the DMV.
To verify your occupancy, a lender may reach out to you and ask for documents like paystubs, bank statements, an electric bill, or an updated driver’s license. Updating your address through these channels will provide you the paperwork you’ll need to prove where you live, should anyone ask.
Based on the terms of the loan agreement you sign at closing, you have to occupy a principal residence within 60 days and reside there for at least one year. After one year, if your plans have changed and you want to convert your principal residence to a second home or investment property, contact your lender to let them know ahead of time.
It’s possible that you’ll never be asked to verify your occupancy as a condition of your loan. But because so much can hinge on your ability to verify your principal residence as it’s listed on your loan agreement, it’s better to be prepared.
Can I claim the property as my principal residence or second home, then rent it out anyway?
While you might be tempted to misclassify your home’s occupancy status, it’s not a risk worth taking. A lower down payment, interest rate, and monthly payment sound great, but passing a rental property off as your home could cost you far more than you’d save in the short-term.
Based on your loan agreement signed at closing, you’re required to move into your principal residence within 60 days, and you must live there for at least one year. As part of regular quality control measures, mortgage companies check up on at least 10% of the loans they close. Part of this quality control process involves re-verifying your occupancy status. If the lender selects your loan for an audit, someone will check to see if you are living in the property according to the terms of your mortgage.
The lender will review any changes to your mailing address, will look over your insurance history to see if you switched to a landlord policy, and they may even hire someone to knock on your door and check that you're residing at your principal-residence property. (Yeah, really!)
Misrepresenting your occupancy is fraud—there’s no way around it. If your lender finds out that you lied about living in the property, they can demand full repayment of the mortgage loan on the basis of this fraud. If you can’t immediately repay the loan in full, your lender can proceed with foreclosure on the property.
So again, while the lower payments, down payments, and interest rates are certainly tempting, misrepresenting your intent to occupy a property comes with a hefty consequence when you’re caught. Being honest with your lender will always result in the best long-term outcome for your loan.
Whether you’re in the market for a primary residence, a second home, or an investment property, NewCastle’s got your back. Using our mortgage calculator, you can see real-time rates for your mortgage and get a down-to-the-dollar estimate of your costs.
Still got questions? We’re here to help. Schedule a call with our team of mortgage experts to get the answers you need.