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How Mortgage Lenders Determine Interest Rates Based on Occupancy Types

Buying a home is both exciting and scary, especially for the first time. Most people have an image in their mind of the perfect home in the perfect location. Of course, this is highly personal and everyone has their own unique take on what makes a home ideal. In some cases, the perfect home is one that can be used as an income source, for others, it’s a place to raise a family and grow old. However, there are two things that every home buyer is most interested in – price and interest rate.

Home Prices

The asking price of a home is determined, in large part, by recent sales of similar properties in the area. In some markets, home values are exceptionally high, while in others they are more affordable. The actual sales price may be lower depending upon a number of factors. The type of property, its condition, and the negotiating skills of the buyer and the real estate agent are just a few.

Interest Rates

Mortgage lenders use a variety of criteria to determine the interest rate they’ll charge a borrower on a loan. The most important factor underwriters consider is generally the individual’s credit history. Those with the highest credit scores are given preferential treatment and offered a lower rate. On the other hand, a person with a low score, and a history of credit problems will be charged a higher rate. A borrower must also demonstrate their ability to repay the loan through proof of income. Another factor lenders consider is the down payment amount. Borrowers who are able to come up with a higher figure are generally considered lower risk and a lower rate will apply.

Property Types & Interest Rates

The type of property being purchased also plays a major role in the interest rate that will be charged. There are three main occupancy types of homes, according to a mortgage lender. The occupancy of a property affects the underwriting guidelines for the mortgage and the associated interest rate. For example, a primary residence cannot produce rental income, whereas an investment property can.

Primary Residence

This is perceived as the lowest risk occupancy type by mortgage lenders. Since the borrower will live in the home, it is less likely that they will miss a payment and therefore the interest rate is generally lower.

Homes are considered the primary residence of a borrower under certain circumstances:

  • It must be occupied by the borrower for a minimum of six months each year.
  • It must be the address of record for the borrower on a state drivers license, taxes, and voter registration.
  • It must be located reasonably close to the borrower’s place of employment or business.
  • The borrower must declare that they intend the property to be their primary residence.
  • The borrower must occupy the home within 60 days of the mortgage loan closing.

Second Home

Generally speaking, interest rates on a second home are between a quarter and half a point higher than those for primary residences. Mortgage companies perceive this type of occupancy as a higher risk since the borrower is not dependent on owning the home to have a place to live. It is a luxury.

A single family home that is occupied by the borrower for a portion of the year are considered second homes if:

  • The home is located a certain distance from the borrower’s primary residence.
  • It is suitable to live in year-round.
  • It is readily available to the borrower to use.
  • It is not subject to any shared ownership agreements such as time sharing.
  • It is not subject to any rental pools or revenue sharing arrangements.

Investment Properties

Of the three occupancy types, income or investment properties carry the highest risk for lenders. Therefore, they charge higher rates for these mortgages than either of the two mentioned above. The reason for this may be the fact that investors are more likely to dump a property if it becomes a bad investment than an owner-occupier.

To be considered an income property, a home must meet the following guidelines:

  • The intention of purchasing it is to generate income for the borrower through renting or leasing.
  • The borrower has plans to improve or develop the property to resell it to make a profit.
  • It is a non-owner occupied residence.
  • It can be either a single family, multi-family, or commercial structure.

There are many factors that go into buying a home. Buyers have to decide if it will serve as a full-time residence, second home, or investment property. Its size, style, location, and price are top of the list for most buyers. When it’s time to apply for a mortgage through a bank or other financial institution, interest rates come into play. A buyer who understands what a lender is looking for, and how they determine the rate will have an easier time managing the process. They may also be able to negotiate better terms and conditions.

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