I learned a lot when my wife and I recently decided to buy a vacation/retirement home. I learned that in a really old house bedrooms don’t necessary have to closets to be considered bedrooms – since the clothes hanger wasn’t in common use until after 1900. I learned that you need to really aim for a good basement in Newport County, in RI – they are few and far between and flooding is common. I also learned that KJ’s Pub near first beach in Newport has a terrific wing special ($0.30 cents a wing and it’s a good size wing).
Finally, I learned that mortgage lenders really, really confuse me. Well, to be accurate, they’ve always confused me. You don’t have to go too much further than the sub-prime crisis to have that point drilled home. However, one interaction with a mortgage lender in particular left me more confused than that mess.
The lender asked what our intentions were with the house. Unfortunately, that’s been a very murky question for us. Understandably mortgage lenders don’t like to deal with uncertain situations. It’s simply not worth the risk. We told them that we’d love to move into the home immediately at closing, but due to my wife’s military status (and various accompanying AWOL laws) it might not be possible to get a timely transfer. So then the lender asked if it would be a vacation home or if we intended to rent it out. That’s a fair question. I tend to think a fair answer would have “yes” as it isn’t necessarily an either/or case – especially in a well-known vacation area. However, I needed to give a more firm answer.
The lender then offered an explanation. If it is a 2nd home or a vacation home, he can provide me with a lower interest rate. If we intend to rent it out, it would be classified as an investment property and the interest rate would be higher. Huh?
Maybe it’s just me, but I think that best interest rates should go those situations with the least chance of defaulting. That would seem to make sense, right? So if someone were to carry a second mortgage burden, that gets a favorable rate. However, if the same person were to rent out the property and brings in income to offset the cost of the mortgage, that raises a red flag and triggers a higher rate. If it were me lending my money, I’d be much more worried about the person without income from the property defaulting on the loan.
Perhaps a reader can help me understand this logic in the comments, because I can’t make sense of it.
In the meantime, I’m going to bask in the fact that I can get free credit scores from Credit Sesame. It’s one less thing to worry about.
Random guess (I am not an accountant):
I’m guessing if you’re purchasing the property with the intention of renting it out you’re more likely to be looking at the property with an investment mindset rather than forming an emotional attachment. As such if the property value goes south if you’re an investor you’re more likely to make a strategic default, rather than holding onto a property you’ve fallen in love with.
I guess I can see that point of view.
This opens up a third classification though. What about retirement homes? We are viewing this as a place to retire in a 7 year time frame. It would seem that declaration would give the lender the best of both worlds and even lead to better rates. It’s the assurance it is a property that one has fallen in love with, with the emotional attachment and such. It also shows fiscal responsibility and lower the chance of default by generating an income from the property leading up to the point.
It’s possible that rental properties are actually more risky, but IMO it’s more likely that the government is behind this – aka providing incentives or plain requirements for lower interest rates to home-owners as opposed to investors.
This practice has been in place long before the strategic default was in place though. So I think, similarly, the best interest rates go to primary residences since that’s your first priority to maintain when your personal finances go south. It can be much harder to get approved for a mortgage for a second home, vacation, or investment property so they are taking your finances into account; it just only goes so far.
It would be hard for a bank to judge your qualifications as a landlord and do due diligence on rental comps in the area. If you had a reliable track record as a real estate investor/rental owner you might be applying for a business loan or a mortgage as a business instead of a vacation home as an individual.
It turns out that interest rates for primary residences and second homes are the same. This was surprising to me as well. Why would they deem the second home, which may be vacant, as having the same rates as the first, which presumably is occupied. People get house sitters to occupy houses, so it would seem to be that occupancy is better. Having renters gives you that.
It would be just as hard for a bank to judge my qualifications as home owner as well. Even if I was really bad and rented the place for 30% of it’s actual value, it’s still 30% more money than I’d get as a second home and that’s 30% more money that can be put towards a mortgage payment.
I should mention that since we were able to show income to satisfy the second home requirement, it also shows that if we were completely unable to rent it out (or rented it out for less that it’s worth), we’ve shown that such income would be considered “gravy.” I can’t imagine someone getting business loan for a retirement home. I think mortgage rates are a lot better. Maybe if the business was incorporated and if that business was to hold the deed that would come into play. That’s a scenario that isn’t happening here though.
It probably has a lot to do with the fact “that they can”.
Why does any place offer discounts to non-profits and such? Is the product cheaper to produce for those groups?
No.
The groups that are the most profitable can afford to pay more for the same goods (or so is thought).
In this case the landlord pays the higher rate as they are profiting from the “goods”.
disclosure: I am a fellow landlord of rental property who also thinks that this is stupid.
Jon
I think that makes some sense. Though I can’t fully buy it. They’d charge people with second homes more than a primary home because they can too. They’d also charge those with higher incomes more than those with lower incomes because they can.
Yes, but it’s easier to lie about a mortgage application for a 2nd home or vacation home (being your primary), etc and more banks competing for it. It is a little bit harder to get a commercial loan with more stipulations.
Banks threw all kinds of “old” rules out the window during the housing boom to get as many people into homes as possible. That didn’t happen as much on the commercial side…
Yeah, since it’s easy to lie about an intention of second home vs. investment property for a mortgage application, it seems to make even less sense to ask such a question.
Maybe you discovered an ineffiency in the market. If banks are currently overcharging for the risk associated with rental property mortgages, then you should swoop in and start lending out money at a rate that you think is appropriate.
Perhaps I did discover a an inefficiency in the market. However, I tend to lack the scale and the backing of such organizations like Fannie Mae and Freddie Mac. I think I can a better return on my dollar than using my money as a mortgage lender.
Ditto you could get a better return than as a mortgage lender… especially with current interest rates and the rise of the strategic default.