Primary Residence Mortgage: Definition & Benefits
BL
Summary:
A primary residence is a property where you either live or spend the majority of your time. A mortgage on a primary residence can differ from other mortgage loans and has special terms that are usually advantageous to the borrower. As owning a home is part of the “American dream,” the government has enacted specific policies over time that ensure people can get into the housing market. Some of those policies apply to primary residences.
The first entry that comes up when you Google the definition of primary is “of chief importance, the principal.” It can also refer to something happening first chronologically, but most people use it to signify importance. When it comes to the house where you live or spend the majority of your time, the IRS considers this your primary residence or residence of “chief importance.”
It’s crucial to understand that from a government perspective, your primary residence is incredibly important. In the U.S., the ability to own your home is part of the iron-clad American dream. Therefore, people buying their first home or switching their primary residence have advantages. From a tax perspective, you can gain certain benefits from a primary residence, such as exclusion from capital gains taxes and the deduction of mortgage interest. From a lending point of view, a primary residence can have more flexible terms like a lower down payment, a lower interest rate, and other special terms.
Compare Home Loans
Compare rates from multiple vetted lenders. Discover your lowest eligible rate.
What is your primary residence?
According to the IRS, your primary residence is where you spend the majority of your time inside the U.S. If you live in one home your entire life, this is your principal residence and will always be your primary residence. It’s not an investment property or even a second home; it’s where you live primarily. If you live in more than one home, however, the IRS needs to see what they call “facts and circumstances” to qualify a residence as your primary residence. Designating a home as your primary residence has both tax implications and lending implications. Here are the facts and circumstances the IRS takes into account:
The address listed on your:
- U.S. Postal Service account
- Voter registration card
- Federal and state tax returns
- Driver’s license or car registration
The home is near:
- Where you work
- Where you bank
- The residence of one or more family members
- Recreational clubs or religious organizations of which you are a member
For some IRS tax exclusions, such as the exclusion of capital gains taxes, you will need to prove your primary residence via a “use test.” According to the IRS, to claim the exclusion, you must meet the ownership and use tests. This means that during the five-year period ending on the date of the sale, you must have:
- Owned the home for at least two years (the ownership test)
- Lived in the home as your main home for at least two years (the use test)
It can take a bit of time to reap the tax benefits given to your primary residence. However, the benefits to your mortgage loan can be felt right away.
Primary residence mortgage 101
Just like a primary residence gives you tax benefits, it can give you loan benefits as well. You can obtain a mortgage on a primary residence in a few different ways. Usually, it’s the mortgage attached to the new home where you are going to live. However, you could buy in cash and re-mortgage the property. Or you could do a cash-out refinance and replace your existing loan with another one under the terms of a primary residence mortgage. Here are some of the benefits you receive with a primary residence mortgage.
Low down payment
Back in the days of subprime mortgages, there used to be all sorts of mortgages available with no money down. These days, many lenders require a 20-25% down payment for a property, with as little as 15% for those with immaculate credit. With primary mortgages, though, lenders will usually require only 5%, with some requiring as little as 3%. The small down payment allows many more people to get on the housing ladder and live their American dream.
Interest rates
A primary residence mortgage will often have a lower interest rate than a second home or investment property. The lender sees this loan as less risky since you have to live there. Thus, the mortgage rates should reflect this risk profile and be lower than a standard mortgage. The mortgage interest paid on a primary residence mortgage will be much lower over time than the interest paid on another home loan.
Mortgage interest tax deduction
You can deduct mortgage interest from your taxes on up to $750,000 of your mortgage for the life of the loan. Married couples filing separately can deduct the interest on up to $375,000 each. This means that every year, the interest you pay on your loan (or at least some of it) is not taxable. This is a government incentive and thus should be viewed through the lens of the government encouraging home ownership.
Special loan offerings (VA loans, etc.)
There are special types of loans that are only available through a primary residence mortgage. For example, people who served in the military can get a VA loan with amazing terms. In many cases, these loans require no down payment and have a very low interest rate. VA loans are different than FHA loans as they are backed by a different part of the government, the U.S. Department of Veterans Affairs.
In fact, many veterans may be missing out on the benefits of a VA loan, according to Robert Greenbaum, Chief Marketing Officer at AAFMAA Mortgage Services LLC. “Veterans often don’t realize all the benefits and advantages VA home loans have to offer,” Greenbaum says. He notes that these benefits include:
- Up to 100% financing, which means no down payment may be required
- No minimum credit requirements set by the VA (however, some lenders may require a minimum FICO score)
- No monthly mortgage insurance (A VA funding fee is required, although disabled and other veterans may be exempt from this fee.)
Lender’s parameters for primary residence mortgages
Like the IRS, lenders want to see proof that you will use the home as your primary residence. Usually, this is as follows:
- You intend to live in the home for most of the time. If you are simply switching one primary residence for another, then this is pretty simple.
- You must be reasonably close to your workplace. This means if your actual office is in Kuala Lumpur, Malaysia, you could have issues.
- You must move into the property within 60 days of closing.
- You cannot convert the home into an income-producing property within 12 months of closing. (Don’t sign a property management agreement related to your property with anyone!)
Why are primary residences different? Risk and politics
So why does the home you live in get treated differently than a second home or investment property, both tax-wise and mortgage-wise? The answer lies in politics and risk.
The American dream + rising housing prices = good politics
With housing prices, politicians are naturally in a pickle. They want housing prices to go up, as there is a distinct correlation between rising housing prices and political success/favorability ratings. However, if they become too high and unaffordable, then that’s also bad politics, as people can’t afford homes.
Offering incentives for a primary residence solves these issues. Politicians can make it affordable to get on the housing ladder with tax breaks and other incentives, which causes prices to rise as more first-time buyers enter the market. This is a best-of-both-worlds philosophy, but if government intervention becomes too intertwined in the housing market, it can send prices too far up.
Your loved ones under one roof = less risk of default
From a lender’s perspective, their only prerogative is to make sure that they get their loan back on time with the interest paid. As a primary residence is where, in most cases, you and your family live, then the lenders see your motivation to stay there as paramount.
Remember, lenders are in the business of risk mitigation, and they are willing to give more favorable terms if they see the risk being lower. If you’re ready to find a lender for your next home, compare your options below.
FAQ
How do banks determine primary residence?
Banks determine if a home is your primary residence by your intent to live there. After you have obtained the mortgage, you need to move into the property 60 days after closing, and you are not allowed to convert it into an income-producing property. Anything that deviates from these terms could be considered mortgage fraud.
Can a borrower have two primary residences?
No, you cannot legally have two primary residences. You can have a secondary residence and apply for a mortgage using different terms than you would get with a primary residence.
What is the difference between a primary residence and a second home?
The primary residence is where you spend the majority of your time as well as other elements dictated by the IRS (your postal address, proximity to work, etc.).
What does FHA consider primary residence?
According to the U.S. Department of Housing and Urban Development, the FHA considers a property a primary residence if the borrower spends a majority of time there. Many people have both a primary and secondary residence. But the FHA will be pretty strict about the time you spend in one place and how it relates to your classification as a primary residence.
Can my wife and I have different primary residences?
Nope, sorry, the IRS is pretty strict about married couples only having one primary residence.
Key takeaways
- A primary residence is where you live or spend the majority of your time. A mortgage on a primary residence is different than that of a standard mortgage loan.
- A primary residence mortgage will require lower down payments and come with tax breaks and lower interest rates. It will also qualify for special loans such as a VA loan.
- The lender will want to make sure you intend to live in the primary residence, and that you move in within 60 days of closing.
- There are reasons, both political and related to risk, why primary residences get favorable treatment.
Share this post: