Which tax advantage is not associated with owner-occupied personal dwellings?

If you are considering investing in real estate as an owner occupant, you have access to several financing opportunities. Here are some attractive options to consider.

FHA Loans

An FHA loan, backed by the Federal Housing Administration, allows you to put down as little as 3.5% on a property. Many homeowners choose to pursue an FHA loan due to the low credit requirements. Plus, you could even have the closing costs rolled into your loan.

FHA loans are only available to homeowners that will use the property as their primary residence. With that, you must move into the property within 60 days of closing to qualify for an FHA loan. But you’ll be able to buy a property with up to two units through an FHA loan, which opens opportunities for real estate investors.

VA Loans

VA loans are backed by the Department of Veterans Affairs. This type of loan is only available to members of the military or veterans that meet the service criteria.

If you qualify for a VA loan, you’re able to put down 0% to close on the property. But you’ll have to pay a funding fee. VA loans are especially attractive because there’s no private mortgage insurance attached.

VA loans will allow borrowers to finance a single-family home or a property with up to four units which can double as a rental property. Like the FHA loan, you’ll need to use the property as your primary residence if you pursue a VA loan. That means that you’ll need to move into the property within 60 days of closing.

Conventional Loans

A conventional loan is not backed by a government agency. With that, the requirements for obtaining a conventional loan are more stringent. In most cases, you’ll need to have a credit score of at least 620 and a debt-to-income ratio (DTI) of less than 50%.

But if you can qualify for a conventional loan, you may be able to put down as little as 3%. As far as occupancy requirements, you’ll need to check with your specific lender before moving forward to ensure you can qualify.

Non-owner occupied is a classification used in mortgage origination, risk-based pricing, and housing statistics for one- to four-unit investment properties. The classification means that the owner does not occupy the property. The term is not typically used for multifamily rental properties, such as apartment buildings.

Key Takeaways

• Non-owner occupied is a real estate classification that means the property owner does not occupy the property as their personal residence.
• The accurate classification of a property as non-owner occupied is important for lenders to determine the interest rate that they will charge borrowers and to ensure they are adequately compensated for the risks they take in lending money.
• Because borrowers of non-owner-occupied properties are more likely to default on their mortgages, lenders will charge them a higher interest rate than a mortgage on an owner-occupied property.
• Occupancy fraud occurs when a borrower lies to a lender, claiming that a property will be owner occupied when, in reality, it will not.
• A borrower can use a non-owner-occupied renovation loan to purchase an investment property and pay for the costs to repair the property for future tenants.

Understanding Non-Owner Occupied

The accurate classification of property is important for real estate lenders to determine the interest rate that they will charge a borrower and to ensure they are adequately compensated for the risks they take in lending money for a purchase. A mortgage on a non-owner-occupied property might have a slightly higher interest rate than a mortgage on an owner-occupied property. This is because borrowers of non-owner-occupied properties are more likely to default on their mortgages.

Because of the higher interest rate, some unscrupulous borrowers will try to classify a non-owner-occupied mortgage as an owner-occupied mortgage to receive a lower interest rate and save money. This is a type of mortgage fraud known as occupancy fraud.

Occupancy fraud occurs when a borrower lies on a mortgage application regarding whether or not the property will be owner occupied. If discovered, the borrower could face many repercussions, including prosecution for bank fraud or a demand from the lender that the entire mortgage balance be repaid immediately.

In some situations, renting an owner-occupied property may not be occupancy fraud, such as when a homeowner must move elsewhere for a job. To avoid unintentionally committing occupancy fraud, borrowers should contact their mortgage lenders before renting owner-occupied properties to tenants.

Non-Owner-Occupied Properties and the Real Estate Market

In many cases, non-owner-occupied properties refer to condominiums and other single-family homes that are owned and rented out to others. Non-owner-occupied properties require insurance coverage before renters can use them. Furthermore, if the property is not rented out to tenants, and if it is intentionally vacant with no occupants, then a different type of property insurance will be necessary.

Buying and renting out properties for other residential occupants represents a significant part of the overall real estate market. Those who invest in these properties typically search for properties that need repairs but offer the possibility of attracting tenants if they are refurbished and repositioned on the market. This could also apply to different types of vacation properties that are not the primary dwelling of the owner.

Non-Owner-Occupied Financing

There is a class of financing for non-owner-occupied properties specifically for renovation purposes. A non-owner-occupied renovation loan is a type of mortgage that the borrower can use to not only acquire the property but also borrow funds that will go toward the renovation of the dwelling. In this case, the property will not be a turnkey property that the investor can purchase and immediately rent out. The value of such a mortgage is typically based on the value of the property after it has been refurbished and renovated.

While there is no minimum repair work that must be done with the funds from this type of mortgage, the renovations must be a permanent part of the residence. This could include adding a new bathroom, replacing a roof, new plumbing, or paving a new driveway. The renovations must also increase the overall value of the property on which the mortgage was taken out. Cosmetic improvements that increase the appeal of the property are not enough. The repairs and refurbishment must create a tangible improvement to the dwelling’s market value. Such mortgages typically can be used by owners with up to four financed non-owner-occupied properties.

Why is the interest rate higher for non-owner-occupied properties?

Borrowers who do not intend to live in the property as their primary residence have a higher risk of default than borrowers who do live in the property. To compensate for this risk, lenders charge higher rates.

Is it better to refinance or take out a loan on a second property?

That depends on the equity you have in your primary residence. Generally, rates are lower on refinances on primary residences than on non-owner-occupied properties. Get some rates from lenders so that you can do a side-by-side comparison.

Can I get a better rate if I turn a property into my primary residence?

If, after not occupying the property for a long time, you decide to live in it as your primary residence, you may be able to refinance to get a different rate. Keep in mind that every refinance has closing costs, so make sure that you will have a tangible net benefit from refinancing. An example of this would be someone who owns a cabin where they like to vacation who then moves into the cabin full time after retirement. That individual could refinance to get a better rate on their cabin.

The Bottom Line

The term “non-owner occupied property” is expository. A non-owner-occupied property is one in which the owner does not occupy the property. Non-owner-occupied properties have higher loan rates than properties that are owner occupied. This creates a situation where borrowers are tempted to commit occupancy fraud to get lower rates, but committing mortgage fraud is always a bad idea. If you do have a non-owner-occupied property, make sure that your property is insured accordingly.