Can Your First Home Be an Investment Property?

Purchasing a first home is a significant personal milestone and financial commitment. Many individuals also consider how the property might serve as an investment. A primary residence differs from an investment property in financial structures and regulatory considerations. This article explores the feasibility and implications of using a first home as an investment property.

Occupancy Requirements for Primary Residence Loans

Lenders typically offer more favorable terms for primary residence loans, acknowledging the lower risk of owner-occupied properties. These terms often include lower down payments and more competitive interest rates. To qualify, borrowers must intend to occupy the property as their principal residence within 60 days after closing.

The borrower is usually required to maintain occupancy for a minimum of 12 months. Government-backed loans, such as those from the Federal Housing Administration (FHA) and Department of Veterans Affairs (VA), have strict occupancy stipulations. For instance, FHA loans mandate that at least one borrower reside in the home for one year. Conventional loans also impose similar owner-occupancy requirements. Misrepresenting the intent to occupy the property as a primary residence can lead to serious consequences, including loan fraud.

Converting Your Primary Residence to an Investment Property

After fulfilling the initial occupancy requirements of a primary residence loan, it is generally permissible to convert the property into a rental. While lenders typically do not require notification once the original occupancy terms are met, it is important to review the mortgage agreement for any specific clauses. Refinancing the original loan into an investment property loan is often not a mandatory step, but it might be advisable in certain situations. This could be beneficial if the original loan has specific restrictions or if the homeowner wishes to access equity, though investment property loans usually come with higher interest rates and larger down payment requirements.

Updating insurance coverage is crucial. Standard homeowner’s insurance is insufficient for a rental property, necessitating landlord or rental property insurance. This policy provides liability protection specific to renting. Becoming a landlord also introduces operational responsibilities, such as tenant screening, lease agreements, and property maintenance.

Tax Considerations for Your Converted Property

Once a primary residence is converted into a rental property, it incurs specific tax implications. Rental income is taxable and must be reported to the Internal Revenue Service (IRS) on Schedule E. Landlords can deduct various expenses, including property taxes, mortgage interest, insurance premiums, utilities, advertising costs, and property management fees.

Depreciation allows for the recovery of the property’s cost over its useful life, typically 27.5 years for residential rentals, excluding the value of the land. When the property is eventually sold, any depreciation taken will be recaptured and taxed at a different rate, generally up to 25%. The Section 121 exclusion for capital gains on a primary residence sale applies with specific conditions. To qualify, the homeowner must have owned and used the property as their main home for at least two of the five years preceding the sale. The exclusion, up to $250,000 for single filers and $500,000 for married couples, may be prorated based on “non-qualified use” when the property was rented.

Financing Direct Investment Properties

Purchasing a property specifically as an investment from the outset involves different financing considerations. Loans for direct investment properties typically require larger down payments than primary residence loans, often ranging from 15% to 25% for conventional loans, and 25% to 35% for hard money loans. This higher requirement reflects the increased risk lenders perceive with non-owner-occupied properties.

Interest rates for investment property loans are also generally higher than those for primary residences, often by 0.5% to 1.0% above conventional rates. This difference is due to the higher risk of vacancies and non-payment associated with rental properties. Lenders impose stricter qualification criteria, including higher credit score expectations and lower debt-to-income (DTI) ratios, commonly preferring a DTI below 43%. Existing mortgage debt on a primary residence can impact a borrower’s DTI when applying for an investment property loan, though potential rental income from the new property can sometimes be considered to offset this. Unlike primary residence loans, there is no personal occupancy requirement for these loans.