How to Finance Your Future Short Term Rental Investment Property

With the rise of services like Airbnb and Vrbo, vacation homes and short term rental properties continue to spike in popularity. According to Forbes, “in 2021, the U.S accommodation sector saw $319.9 billion in revenue, which is expected to increase by 13% in 2022. Short-term rentals, whether in apartments or private homes, accounted for roughly $57.7 billion. And the market share of short-term rentals, as opposed to hotels, shot up from 10.5% in 2018 to 18% in 2021.”

Owning a vacation home or short term rental sounds awesome. Pure and simple. If you’re ready to get started, your first step toward financing is to clearly define your investment thesis; this means deciding why you want to invest, what you want to invest in, and where you want to invest? There is no right or wrong answer. It simply depends on what your STR investment goals are. If you’re looking to purchase a rental for personal use in an area you enjoy visiting, then your goal is likely less about turning a profit and more about proximity, flexibility and leveraging rental income to offset other costs. Conversely, if you’re an investor with an objective of maximizing annual cash flow and/or cash-on-cash returns, you’re likely more focused on revenue potential. 

Here’s a look at several financing options you can explore as you get started on your journey:

Open a HELOC on your primary residence

A HELOC, or home equity line of credit, is a loan based on the current equity within a home. You may be able to access up to 90% of your home’s current value if you choose to open a HELOC. Further, you might be able to draw on a line of credit to pay for your investment property or vacation home depending upon the amount of available equity from your primary residence. When you take out a HELOC, you don’t have to refinance the mortgage on your current home. The new loan and your current loan aren’t connected in any way, but your mortgage rate may vary depending on the type of HELOC you choose.

Refinance your primary home & cash out on the equity

A cash-out refinance is when you convert some of your home equity into cash in order to establish a new mortgage for your primary residence. You may be able to use a conventional loan to buy up to 80% of the value of your current home. The new primary residence mortgage is dictated by factors like your credit score and debt-to-income ratio.

Apply for an investment property loan

This type of loan is designed for properties that are intended to be income-generating. In order to be granted an investment property loan, you typically need: a credit score of 640 or higher to help with the overall terms of the loan, to be able to put down 20% (in most cases), and to have a low debt-to-income ratio. This means that your total debt should be at 45% or less of your monthly income. It’s good practice to have enough money to cover up to 6 months of rent on both residences. It’s also important to note that if the purpose of the investment property is short term rentals, future rental income may not count toward your gross income when calculating.

Apply for a conventional loan

If you’re applying for a conventional loan, your primary residence and second property typically need to be at least 50 miles apart from one another. If it’s less than that distance, then it would be considered an investment property meaning that you’re ineligible to finance through a conventional loan. A conventional loan has a fixed or variable mortgage with a set term and must meet Freddie Mac and Fannie Mae guidelines. This type of loan is not insured or guaranteed by a government agency. According to mortgage company Fannie Mae, you should have a credit score of 620 or higher to apply for a conventional loan. If you’re considering a conventional loan, compare adjustable rate mortgages and fixed rate mortgages as the default loan (30-year fixed-rate) may not always yield the best return.

Have questions? Drop us a comment or send us a message. If you’re interested in viewing our complete portfolio of short term rental and vacation properties, this is a good place to start!