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Should you get mortgage on own home or rental property?

We want to buy a rental property that a relative will live in. Should we use a cash-out refinance on our home that we own free and clear or a non-owner occupied mortgage? Is the property considered owner-occupied because a relative lives in it?

Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience
, Trusted Mortgage Expert with 45+ Years of Experience

In general, you must live in a home for all or part of the year for it to be considered an owner-occupied residence. Second homes and vacations homes are considered owner-occupied residences while rental and investment properties are considered non-owner occupied properties, even if a relative lives in the property. So in your situation, the property you are buying will likely be considered a non-owner occupied property unless you also intend to reside in the property for part of the year.

In terms of your financing options to purchase the home, there are several factors to consider. First, we typically do not recommend that borrowers mortgage their primary residence to purchase another property if they own their home FREEandCLEAR. Although it is unlikely, something unforeseen could happen that could cause you to default on the mortgage and lose your primary home. While the probability of something this negative happening is probably very low, it is something to keep in mind from a financial planning and peace of mind standpoint.

If you are comfortable with the risk of taking a mortgage out on your current home then you should understand the pros and cons of doing a cash-out refinance. On the positive side, the interest rate on a cash-out refinance should be slightly lower than the interest rate on a non-owner occupied mortgage. Additionally, the interest expense for a mortgage on your primary residence is tax deductible, which is another benefit. On the other hand, some lenders may limit the amount of money you can take-out with a cash-out refinance and may also inquire about the use of proceeds. Policies vary by lender so make sure you can take-out sufficient proceeds with a cash-out refinance to purchase the property you want to buy, if that is the financing alternative you choose. We provide a thorough overview of a cash-out refinance on FREEandCLEAR for you to review.

There are also pros and cons associated with a non-owner occupied mortgage. Using a non-owner occupied mortgage in your case is certainly simpler and exposes you to less risk. Although the interest rate on a non-owner occupied mortgage is usually slightly higher than the rate on an owner-occupied loan, interest rates are near all-time lows so the difference in monthly mortgage payment should not be too much. Considerations for a non-owner occupied mortgage include potentially more challenging qualification requirements such as a lower maximum loan-to-value (LTV) ratio, although some lenders also limit the LTV ratio for a cash-out refinance. We provide a comprehensive overview of non-owner occupied mortgages and interest rates on FREEandCLEAR.

From a tax standpoint, the interest expense on a non-owner occupied mortgage is typically not deductible against your personal income but is deductible against any rental income generated by the property. We are not tax experts so we recommend that you consult an accountant or tax professional to understand the tax consequences for the mortgage you select.

With either financing option, lenders will also review the projected cash flow profit or loss from the property (rental income minus total monthly housing expense including your mortgage payment, property tax and insurance). If the property is projected to produce a cash flow loss then lenders will want to make sure that you generate sufficient personal income to pay both the mortgage and cover the loss.

Although there is no definitive answer to your question, on balance our preliminary recommendation would be to use a non-owner occupied mortgage to buy the property. Although the interest rate is slightly higher, a non-owner occupied mortgage provides the simplest and safest financing alternative.

We recommend that you contact multiple lenders to understand how they would handle your unique situation. You can review lenders in your area by clicking INTEREST RATES and we advise you to contact three-to-four lenders as underwriting policies and guidelines can vary. We also offer a separate INTEREST RATES function for non-owner occupied mortgages.

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About the author

Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR. More about Harry

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