Should you get a second home or an investment property?

Getting ready to purchase a second property is an exciting time in your home ownership journey. The opportunity to own another property for vacations or for generating extra income both have a high appeal. But when deciding if you want a second home versus an investment property, there are important factors to consider, which includes mortgage requirements and tax implications, which differ for each. 

Here’s everything you need to know about the differences when purchasing a second home or investment property to help you decide which one is best for you. 

What’s the difference between the two?

Getting a second home

A second home is defined as a second property you purchase that you plan on living in for part of the year--or other members of your family, like your parents or even your kids who might be going to University in the area, for example. This can be a cottage, a vacation home, or even a condo, elsewhere, that you occupy during part of the week. The important factor to classify it as a second home is that you have to occupy it for part of the year, at least 14 days per year, while you’re also living at your primary residence. 

What might surprise many people about a second home is that, depending on your lender and their vacation home lending program, you’re actually allowed to rent it out for part of the year, without it being considered an investment property. As long as you live in the home for a minimum of 10% of the days that the home is rented (or at least 14 days per year), your second home is allowed to be rented out. This can include summer rentals both short or long term that can help you generate additional income. 

The bonus is that the income generated from a second home isn’t tax deductible–as long as you’re occupying the home for the minimum period of time required. The downside, though, to this is that you’re not able to claim any expenses or renter tax deductions.

Getting an investment property

An investment property on the other hand, is a property purchased for the sole purpose of generating income by renting it out to a third party. Unlike a second home, there is no minimum occupancy required by the owner, however the property must be a single family unit and can’t be rented. A family member of the owner must be living in the property, rent-free. 

How do the mortgage requirements differ for these properties?

When you apply for a second mortgage, you’ll be asked if the home is going to be used as a second home or investment property. And depending on what type of property you’re purchasing, the requirements for lenders can vary. For the most part, many of these qualifying criteria are the same as purchasing your first home: passing the mortgage stress test, having a good credit score, and a regular source of income. 

Financial Considerations and Benefits of a Second Home

When contemplating the purchase of a second home, it's essential to understand the financial implications and potential benefits. Here are some insights from various sources:

• Down Payment Requirements: For a second home, the down payment can be as low as 5% if the property's value is under $500,000 CAD. However, for any purchase price over $500,000 and under $1,000,000, a minimum of 5% down is required for the first $500,000, and 10% for any amount above $500,000 but below $1,000,000. For properties over $1 million CAD, a minimum down payment of 20% is typically required.
• Tax Implications: If you earn rental income from your second home, you can write off many of the expenses incurred. This includes property taxes, utility costs (if not covered by the tenant), professional fees.
• Potential Earnings: If you're considering buying a second home for personal use, the profit will likely come from the eventual sale of the property. However, renting out the property, either partially or entirely, can generate consistent income.
• Financing the Down Payment: If you've owned your primary residence for some time, you can use your home equity to finance the down payment for your second home. Options include a cash-out refinance, Home Equity Line of Credit (HELOC), or a reverse mortgage.
• Closing Costs: Remember to factor in closing costs when buying a home in Canada. These costs typically range from 3% to 4% of the home purchase price and include expenses like property appraisal, land transfer tax, legal fees, and more (like repairs and cleaning), advertising fees, and insurance costs

The bottom line: pros and cons

All in all, both a second home and investment property each have their pros and cons that make them good options for a second property. 

Considerations:

• Financing: Investment properties typically require a larger down payment (often 20% or more) and might come with higher interest rates.
• Maintenance and Management: Owning a rental property means you'll either need to manage the property yourself or hire a property manager, which can eat into your profits.
• Vacancy Risks: There's no guarantee your property will always be rented out, leading to potential income gaps.
• Market Fluctuations: The real estate market can be unpredictable. While properties might appreciate, they can also depreciate based on various factors.

At the end of the day, it all comes down to your preferences when choosing what your goals are with a second property, whether it be a vacation option or a stream of income. If you're looking for a personal retreat with occasional rental potential, a second home might be the way to go. However, if you're looking for a more hands-on investment with a steady income stream, an investment property could be a better choice. Once you’ve found your potential second property, one of Pine’s mortgage agents would be happy to speak with you to help with this next stage in your homeowner journey.