What Impact Does a Property’s Occupancy Have on Your Mortgage?

Team Simplist
Sep 1, 2021

Why should the type of property you’re financing affect your mortgage rate? As with many mortgage questions, the answer lies in the lender’s risk.

There are a variety of factors at play when it comes to determining your mortgage approval. Among other factors, your lender will look at your credit history, debt-to-income ratio, job history, and current assets. One thing you may not have considered is the occupancy type for the home you’re purchasing and how it can affect the lender’s decision-making process.

Let’s say you have a stellar credit profile, a decent amount of equity in your current home, and are getting ready to buy a vacation home on the beach (we’re jealous). You might be expecting to sail through the mortgage approval process with similar terms to those on your existing loan. But not so fast... If the numbers add up, you should be able to secure financing—but it’s important to know that there is a distinct difference in the way that lenders approach the risk involved in various properties and types of occupancy. Crucially, that difference could have an impact on your financial bottom line. Let’s dig in:

Types of Occupancy

There are three key types of occupancy that a lender considers when determining your mortgage readiness:

Principal The principal, or primary, residence is the one that you and your family live in most of the time. It is the address that will be listed on your state and federal tax returns. It can be a single-family home or it can be a duplex, triplex, or quad, with the other units rented out.

Secondary Defining a secondary residence or second home is somewhat more complicated than defining the primary residence. Here are some of the biggest differences that apply to the second home:

  • Borrower must occupy the property for part of the year, but less than the majority of the calendar year
  • Year-round access and occupancy must be possible
  • Borrowers, (not a management company or other entity,) must have exclusive control of the property
  • Property must be a one-unit dwelling
  • Property cannot be a rental property or timeshare

In other words, a secondary property must be designed and available for your personal use year-round. While it might sound restrictive, the rules here are designed to differentiate these dwellings from investment properties.

Investment An investment property is one that is purchased for the purpose of either seasonal or year-round rental. It may also be a property that you purchase with the intention of flipping it for resale. Even short-term investment properties are categorized as investments, not as secondary properties.

For example, say you buy a vacation home intending to use it for quick getaways throughout the year. However, you decide to rent it out for a month or two during the most active part of the tourist season. That property is still considered an investment property, not a second home.

Mortgage Cost and Occupancy Type

Why does your lender care so much about how you’re using the property? After all, it shouldn’t matter to the lender whether you’re living in the home or someone else is living there, as long as you’re making the payments, right? This is where we come to the risk factor that drives lenders to view various property types differently.

For example, say that you own a primary residence, a secondary residence at the beach, and an investment property that you’re in the process of flipping. Now, consider what would happen if you had a severe personal or financial problem which meant that you could only pay for one of those properties. Which one would you choose?

For most people, the choice would be simple— the primary residence. That’s typically where their belongings are, their family lives, and their future lies. If they can only keep one property, it makes sense to keep the primary so that they have someplace to live and don’t have to uproot their lives.

Now, let’s say they could keep two properties. Which would they choose next? In many cases, the next choice would be the secondary residence. Perhaps it holds fond memories of family vacations. Maybe they bought it to eventually use as a retirement home in a sunny locale with low taxes. They might have plans to eventually pass it on to their children and other family members, and don’t want to let it go for that reason.

For most people, it’s safe to say that the investment property would have the lowest priority. Unless it is a significant source of income or they could monetize it quickly to get them out of their current financial distress, the investment property is probably a financial drain. If they need to put money into it to make it marketable or if it is currently unoccupied, many investors would let that property go back to the bank in order to ease their debt burden.

Thus, occupancy type has a big impact on the risk that the lender undertakes and their chances of having their loan paid back in a timely manner. That’s why lenders may charge higher interest rates to offset that added risk. In some instances, they may also require a higher credit score and larger down payment.

Converting Occupancy Type

If you want to change your primary or secondary residence into an investment property, you’ll need to check for an occupancy clause in your mortgage. This will outline the conditions under which you can make this type of change or whether you will have to refinance your mortgage in order to convert to a different type of occupancy.

If applicable, you should also check with your homeowner’s or condominium association to find out if there are restrictions on occupancy type in your community. In some cases, residential associations limit the number of properties that can be renter-occupied in order to maintain home values and avoid issues with upkeep.

Tax Considerations

There are a variety of tax implications that apply to the various types of occupancy and to changes from one occupancy classification to another. It is important that you both understand these and consult with your financial professional any time you are contemplating making a change to your real estate portfolio.

Whatever type of property you’re interested in financing, you’re sure to find the right solution at Simplist. With thousands of mortgage options and a team of licensed loan experts just waiting to answer your questions, we’re here to help—wherever you are in your homeownership journey.

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