learn airbnb

As of June 2021, there were approximately 1.32 million active rental properties in the United States alone, and analysts project those numbers will continue climbing for the foreseeable future.

This increase in Airbnb and Vrbo activity is incenting investors to purchase vacation properties used for short-term rentals during busy travel times. While many of us want in on the action, we must first research the vacation rental property loans available.

Why Short-term Rentals?

For many years, short-term rentals were inefficient and prohibitively expensive.

Limited technology forced property owners to advertise their rental units through local newspapers or management companies. These options are not only expensive but also limited in scope – local listings will not reach out-of-town tourists looking to visit the property owner’s area.

However, the introduction of online platforms such as Airbnb and Vrbo have streamlined the advertising process. Travelers can now research vacation rental properties anywhere around the globe and stay in actual residences – complete with kitchens and outdoor areas – for the price of a comfortable hotel room.

The demand for short-term rentals is exploding to the point where the industry not only withstood the COVID-19 shutdown but actually thrived during much of the pandemic.

How Can I Secure a Vacation Rental Property Loan?

There are many financing options available, but five common vacation rental property loan structures are as follows:

1. Conventional Financing

We can look to finance our vacation home by applying for a conventional second mortgage.

The procedure is nearly identical to that used for purchasing a primary residence. The loan will require an upfront down payment and then follow a predetermined schedule of principal and interest payments that span 5 to 30 years

.

We will have the option to pay either a fixed or adjustable rate on the loan, and current interest rate levels will likely determine which route we take. If rates are lower than their historical averages (meaning they are expected to rise in the future), we might choose to lock in a fixed-rate loan. If rates are higher than their historical averages (meaning they are expected to fall), we might choose an adjustable rate.

2. Cash-Out Refinancing

On average and over time, property values increase.

When we build sufficient equity in our primary residence when it is also appreciating, we can execute a cash-out refinancing to secure a loan for our new vacation rental property.

For example, let us assume we currently owe $150,000 on our existing mortgage, but the property itself is currently valued at $300,000.

In this case, we would execute a refinancing into a larger mortgage that reflects the property’s current market value. We would then use the new loan to pay off the existing mortgage and use the remainder as a down payment on the vacation property.

If we have good credit, that new mortgage could be as high as 80% of the property’s market value. In this case, that would be $240,000. If we assume closing costs of $5,000, we will have $135,000 in cash after paying off the current $100,000 mortgage.

3. Asset-based Loan

Asset-based loans differ from traditional vacation rental property loans in that mortgage approval is based primarily on the expected income of the rental property rather than on our employment and overall financial standing.

Lenders will look at the property’s estimated income and calculate the Debt Service Coverage Ratio (DSCR) – which is the property’s net income divided by the total debt service – to approve the loan.

An asset-based loan can be particularly attractive when we invest in short-term vacation rental properties because borrowing capacity is not predicated on our personal employment income.

Rather, we need only provide sufficient evidence that the properties will generate the necessary positive cashflows to cover both the up-front expenses and ongoing mortgage payments.

4. Home Equity Line of Credit

A home equity line of credit (HELOC) is like a cash-out refinancing in that we leverage our primary residence’s current market value, but we do not refinance the existing mortgage.

Instead, we take out a line of credit against our home’s market value to make the down payment on the vacation home (or purchase the property outright if possible).

Our primary mortgage will remain outstanding while we secure a second and separate mortgage with different terms.

5. Investment Property Loan

Investment property loans are designed specifically for rental homes used as income-generating properties.

Their associated interest rates tend to be slightly higher (maybe 0.5%) than those seen on conventional loans. Lenders typically require a “good” credit score (usually 650 and above) and a 20% down payment.

Most lenders will also look closely at your debt-to-income (DTI) ratio, which equals your total monthly debt payments divided by your gross monthly income. This metric measures what percentage of your income goes directly to monthly debt obligations. Lenders typically require a DTI of 45% or lower.

Future income from short-term rentals will most likely not count toward gross income for purposes of the DTI ratio calculation.

Get The Right Loan for Your Rental Property

While purchasing short-term rental properties such as Airbnbs and Vrbos can be valuable investments, securing the right vacation rental property loan might be crucial to that investment’s success.

At Vacation Rental Loans, we understand that everyone’s situation is the different. You need financing tailored to meet your specific objectives. We have a team of experienced loan professionals that will work with you to secure the loan that works best for you.

Contact us today to request a quote.