If you have ever considered putting your existing home to work for you as a rental or income-generating property or if you’d simply enjoy owning a vacation home for personal use or also as an opportunity to earn passive income from a property, then there are four main considerations you must keep in mind.
Vacation Home or Income Generating Property Defined
Is there a difference between a vacation home and an income-generating property? Yes. An income-generating property can take on many forms. From renting out your primary residence once you move away from it, to owning a multi-unit property, or owning a secondary home used for your own leisure but also as something you rent out on a short-term basis, any property that isn’t your primary residence that produces income, can be considered an income-generating or investment property.
According to Investopedia, the IRS deems a second home an investment property if you spend less than two weeks staying in it and attempt to rent it for the rest of the time.
Loan Requirements + Stipulations
As such, there are special regulations, stipulations, and loan requirements to make sure any investment properties are handled legally and correctly. For starters, owning an investment property requires a much higher rate of financial stability. Many banks or mortgage lenders require upwards of a downpayment of between 15%-20% and often the minimum credit score is higher for those seeking a loan for an investment property.
Additionally, most also require that the lender use a conventional loan, as loans like the FHA or VA loan do not allow for use other than for a home buyer’s primary residence. Other occupancy requirements state that you must also physically live in the home for a minimum of 12 months before renting it out.
Owning a vacation home or income-generating property can be advantageous but it also comes with significant risk. First, there’s the risk that your property isn’t in as desirable (or rentable) an area as you hoped. This can lead to lapses in tenants or vacation renters. Second, there is the unpredictability of a high rate of vacancy. Third, as an owner, you are ultimately responsible for making the mortgage payment on a property if your tenant cannot. The economy can play into this as well. Most recently, during the pandemic, there was a time when tenants were not required to pay landlords their rent. Finally, you must deal with the wear and tear on your property, maintenance issues, as well as unexpected costs that arise.
Again, most of these risks point back to the fact that owning an investment property usually requires a high rate of financial stability, including keeping a hefty amount of cash on hand in reserve for any of the potential pitfalls associated with someone else living in a space that you are legally responsible for.
However, owning a secondary home, vacation rental, or income-generating property isn’t all bad. Many people have used this form of investment to grow their net worth and their overall financial portfolio in what can feel like a very passive way. Once the expense of buying the property has been taken care of and there’s a system in place for maintaining it, then owning another property could be a lucrative transaction.
In addition to the potential for passive income, an investment property can also provide significant tax benefits, including deducting operating expenses, depreciation, capital gains tax deferral, as well as avoiding FICA tax.
If you are considering delving into the world of investment property ownership, be sure to consult a range of professionals in this field including a licensed real estate agent, a banker, a mortgage lender, and a CPA.