How to Finance a Vacation Rental

Looking to invest in a vacation rental? It’s a popular real estate strategy, and for good reason; demand is constantly increasing and they can provide high returns.

Wondering how to finance the property? It’s not as hard as you think. In fact, most people who finance a vacation rental make less than $100,000 per year. So you don’t need to have an extremely high income to make it happen.

But what does it take to acquire financing on your first vacation rental? And what loan programs are available to you? Keep reading to learn how you can get started investing in short-term rentals.

Why Should You Invest In a Vacation Rental

There are many reasons why a vacation rental is a perfect addition to your wealth-building portfolio. For starters, it’s a piece of property that will appreciate in value an average of 3% per year.

If you have a mortgage on the home, then every payment you make will also help increase equity, growing your net worth. And of course, renting it out to vacationers can not only pay the housing expenses but also earn you a profit.

The vacation rental business is booming. As millennials are becoming the dominant traveling generation, the demand for vacation rental homes is greater than ever.

On top of a lucrative income opportunity, if you buy in a location that you enjoy, you can use the home whenever you need a vacation yourself. 

How to Secure Financing for Vacation Rental Property

When it comes to investing in any type of real estate, there is no one-size-fits-all approach. Your goals, situation, income, and savings all determine how you acquire a property. 

There are many different loan programs available. Because rental properties are at higher risk for lenders, there are more strict requirements for securing a loan.

But regardless of which program or strategy you use, the short-term rental financing requirements will be similar, whether you need financing for a fix-and-flip or vacation rental. Here’s what you can expect.

Financial and Work History

When financing a vacation rental, lenders want an applicant with a reliable income, a long work history, and a solid financial foundation. They take all factors into consideration, including your credit score and history, current debt, income, and assets.

If the property you are buying won’t be your primary residence, you can expect higher credit score requirements. Fannie Mae requires a score of 640 for vacation rentals.

Lenders also prefer to see a DTI or debt-to-income ratio of 43% or lower. This means your monthly debt payments should be no more than 43% of your monthly income.

While you don’t need to be a high-income earner, you do need consistent work history. If you’ve recently changed jobs or industries, that could be a red flag for lenders.

Larger Down Payment

When you are purchasing a primary residence, you’ll notice many loan programs that allow for as little as 3.5% down. But when it comes to a vacation rental, you can expect to need 20% to 25% down to secure a loan.

Cash Reserves

On top of a higher down payment, you’ll also need extra cash reserves saved up. Lenders know that it takes a while before vacation rentals begin earning money.

You may need to remodel the property, furnish it, and build up reviews before you start earning a profit. As such, they generally require you to have up to six months of cash reserves to cover the cost of the property.

Clear Plans for the Home

Your lender also needs to know your exact intentions for the property. WIll it exclusively function as a vacation rental? Or do you plan to use the home as a vacation home?

Determine how you plan to use the property and inform your lender upfront. This will determine the best loan program for you, as well as prevent headaches down the road.

How Do You Finance Vacation Rentals?

Not that you are aware of the requirements, let’s dig into the actual financing options for vacation rentals. This is not an exhaustive list, so be sure to speak with a lender before applying for a loan.

1. Investment Property Loan

If you plan to rent out the property for the majority of the year, there’s a good chance you’ll need to get an investment property loan. These are similar to conventional mortgages. However, requirements can be more strict, as mentioned above.

The benefit of an investment loan is that you can use a portion of your projected rental income to qualify for the loan.

2. Conventional Loan

One of the most common ways of financing a short-term rental is with a conventional mortgage. This will be very similar to the mortgage you have on your home, except that you can expect a larger down payment requirement and a higher interest rate.

Not all lenders will allow a conventional mortgage, or second mortgage, on a property you intend to rent out.

3. Use Current Equity

If you own your current home, you likely have equity available. There are multiple ways to access your equity in order to invest in a vacation rental.

You can perform a cash-out refinance, which gives you a new mortgage on your home while pulling the equity out. Or you can apply for a HELOC, or home equity line of credit. HELOC’s are revolving lines of credit that you will be required to pay back.

If you have enough equity in your home, you may be able to purchase your vacation rental free and clear. If not, you can use this money as a down payment and for cash reserves.

4. 401K Plan

Many 401K plans offer you the ability to invest in real estate. To do this, you essentially borrow money from yourself. No need for a separate mortgage lender, lengthy applications, and closing costs.

This can be an incredible way for many people to obtain their first property.

Get Started Today

Investing in a short-term vacation rental can be a powerful way to generate returns and build your wealth. Plus, you get to enjoy appreciation, tax benefits and get to use the property yourself if you’d like.

There’s no better time to start investing than today. If you’d like to secure financing for your real estate or business goals, be sure to contact us at Alto Capital today.