The following is an excerpt from Christine Karpinski's book, Profit from Your Vacation Home Dream: The Complete Guide to a Savvy Financial and Emotional Investment (Kaplan, 2005, ISBN: 1-4195-0691-9, $19.95).

How will you use your vacation home—as a second home or as an investment property? Determining this makes a difference in the kind of mortgage you should get. (It also has significant income tax implications, but that's an issue to discuss with your tax adviser.)

Second-Home Loans

When purchasing you'll find that interest rates for second-home loans are approximately the same as for a primary property mortgage, with a minimal down payment. Getting a second mortgage on a primary residence is my favorite way to purchase a vacation home because you won't incur “up charges” or higher rates.

This type of loan works exactly the same way as the loan on your primary residence works. Basically, if you made it through the loan process on your primary residence, then you can get through the process of a second-home mortgage. And for income tax purposes, you can convert your property from a second home to an investment property after you purchase the loan to help maximize your income tax deductions.

Be sure to read the fine print in your loan documents. Today, some mortgages come with clauses that state you have to occupy the premises for a certain amount of time for it to qualify as a second-home loan (as opposed to an investor loan). The only caveat is you must be able to qualify under the second home's terms, which means you have to be able to show you can afford it just as you would your first home.

Please note that, under the terms of this loan, there is no consideration for potential rental income. That means if your primary residence mortgage is $250,000 and your second home mortgage is $200,000, then you must to be able to qualify for $450,000 worth of debt. Therefore, if you've maxed out your debt on your primary residence, this isn't the loan option for you. But have no fear; there's a loan out there that will suit your needs.

Investment Property Loans

With an investment property loan, everyone concerned knows you're buying the property strictly as an investment so certain factors come into play. First, the lender wants to know the rental history of the property. Understand that because lenders consider investment loans to be higher risk than mortgages for your primary home, that risk translates into higher interest rates and higher fees. I suggest making your financial decisions based on your break-even formula calculation.