Why are mortgage rates higher for investment properties than for second homes?

Q: I bought a second home I rent to my daughter with the intent she buy it in the future. I have a 5 percent interest rate and I had to buy it down to that since the mortgage lenders I contacted said I had to treat it as investment property. I am not trying to make money on it. Is there a lower worthwhile rate I can get? Someone told me that since it was family that it was possible.

A: As far as mortgage rates go, please know that investment property mortgages usually run about one percentage point above owner-occupied residential mortgages (and can be more or less, depending upon whether fees are incorporated into the interest rate or not).

That said, Fannie Mae and Freddie Mac have recently changed pricing structures for mortgages for second homes, which are now very closely aligned with those for investment property mortgages, so the mortgage rates you'll find for both second homes and investment properties will likely be fairly close to one another.

The increase in fees for borrowers who can afford the luxury of owning a second home is said to have been imposed to strengthen the government-sponsored enterprises’ safety and soundness, and better ensure access to credit for first-time and low- and moderate-income borrowers. These changes came as part of an overall update to Fannie and Freddie's risk-based loan-level pricing adjustments.

As far as family goes, unless your daughter is on the mortgage note and deed, she's not an owner, so an investment financing arrangement would apply.

Investment home

There are some arcane rules for what constitutes an investment home versus a second home.

For one, if you need the income (rent) from your daughter to cover the mortgage on the house or to augment your income to a point where you can cover it, then it's an investment home.

Second home or investment home?

In terms of being a "second home," there are some "distance" requirements which come into play. Even if your income without the rent is sufficient, the home must be a "reasonable distance" away from your primary home to be a "second home," usually akin to about 50 miles or so. It can be closer if the home is in an obvious vacation spot (near the beach, a skiing area, etc.).

If it's just a plain old home not all that far from where you live, the property is usually treated as an investment since you really have no compelling reason to stay there instead of your primary home.

Also, to be considered a second home, the general guidelines also include that you, the borrower, must occupy the property for some portion of the year. If the property and occupancy fail these tests (plus a few others), the property is treated as an investment.