There’s no better way to make money and generate profits than through rental property investment. Notably, there's been a significant rise in short-term rentals. STRs (short-term rentals) are an incredible way to create wealth with passive income from real estate. But there’s one big question: how do you finance and purchase a short-term rental property?
Please keep in mind that there is no single standard way to finance your vacation rental. The truth is that there are a handful of options. And the success of your rental property investment is dependent on a clear understanding of the option that best fits your finances, goals, and current economic climate.
Some of the rental property buying tips many people tend to seek revolve around the following aspects:
How to buy your first rental property
How to make money with rental properties
Rental properties investment strategy
Real estate investing for passive income
investing in a rental property for beginners
How to find investment properties
Our article explores how to finance and purchase a short-term rental property. The discussion will give you essential tips, tricks, and insights to confidently move forward and buy a rental property anywhere.
How Do You Finance and Purchase a Short-Term Rental Property?
We learn from the Techvestor investment experts that it’s crucial to involve well-experienced and highly-versed personnel for anyone to invest right. This is fundamental for a successful investment.
The experts inform us that short-term rental property investors can generate a good passive real estate passive income with an excellent STR strategy. Notably, you can start with as little as $25,000 to get started. So, you get to remain focused and strategic with your investment while keeping expenses down. This explains why many homeowners are now venturing into this industry.
Most people make a good living by renting out their properties to vacationers or business travelers for a few days. That’s why investors everywhere are renovating their properties to accommodate the high demand from guests and travelers who enjoy the nomadic lifestyle.
However, even though short-term rental properties are an excellent investment, they necessitate a thorough understanding of the financing options. Better knowledge in this area will help you start on the right footing.
Find out below how you can finance and purchase a short-term rental property.
1. Traditional Financing Plan
Traditional lending is one great option for financing your short-term rental property. Lenders will often ask that you provide up to 20% of the purchase price as a down payment. They may also ask for proof of the following:
Your income earnings
Good credit history.
The best thing about choosing traditional lenders to finance your rental property investment is that they often offer secure financing and lower interest rates for your investment.
Particularly if you’re wondering how to buy your first rental property, the most common option is the traditional financing plan. The conventional loan is relatively straightforward for many investors. It also offers some of the market’s most competitive and attractive interest rates.
But it’s important to know that this option also comes with the most restrictive lending requirements. Moreso, it’s the least scalable alternative for STR investors that look forward to growing a property portfolio.
Mostly, banks will only give a maximum debt-to-income ratio of around 43%. This means that your borrowing power is restricted by the amount of money you make.
2. Asset-Based Financing
Asset-based financing is also referred to as "commercial loans." Suppose you want to consider a multi-unit property as a way to invest in short-term rentals. In this case, asset-based financing could be the best way forward. Such loans are often financed using the property’s income. The advantage here is that the closing process tends to be faster and requires less documentation.
It’s a practical alternative to buying a vacation rental property. With this type of loan, you can use the investment property’s actual value, or equity, as collateral for the loan’s security. So, instead of using the debt-to-income ratio, the financiers assess your existing or potential earnings from the rental property using the debt service coverage ratio (DSCR).
So, to qualify for the loan, lenders will look at what you might be earning from the vacation rental property and calculate the DSCR (the property’s income divided by the principal, interest, taxes, and insurance).
It helps to know that asset-based financing typically comes with higher interest rates. They may also require shorter repayment terms. So, if you fail to honor the loan agreement, the lender takes full charge of your rental property. The financiers may sometimes ask for a 20–25% downpayment to lower the lender’s risk.
Still, this type of financing for a short-term rental is a huge advantage to any STR investor. This is because your earnings do not limit your borrowing power.
As a real estate investor, you can scale the heights of a property portfolio. Most importantly, you can go ahead and add new rental properties by only providing enough evidence that:
The properties will be a source of cash-flow
There’s enough equity for making the down payments and the associated fees.
3. Hard Money Financing
Hard money financing is a form of short-term bridge loan that’s offered for real estate transactions by individuals or companies. These loans are mainly used to finance rental property investments like vacation rentals or house flipping, which require a faster close with no need for personal or property income.
It’s also referred to as a private mortgage and is an easier way to bypass the traditional loan process. So, you can qualify in as little as 72 hours. However, hard-money financiers tend to offer higher interest rates than conventional lenders.
They also ask borrowers to use the property as collateral for the loan’s security. The loans also come with shorter repayment periods. Besides, the lender may hold off on lending if they doubt whether the property will generate enough income for them to regain funds faster.
But these loans are designed to help those with credit problems qualify for a mortgage faster. Even though the interest rates on hard money loans are typically higher, this option allows those who would not have qualified for other official rental property financing options.
4.Private Financier
You can also seek short-term rental property investment financing from private money lenders. The help can come from familiar sources willing to finance your vacation rental or invest in the short-term rental with you. Such sources may include:
Family members
Friends
Work colleagues
Fellow investors
Any other people you have a close relationship with.
The advantage of such individuals is that they lend their money to you without many requirements. For instance, they do not require a perfect credit score. Again, depending on who the lender is, they may not include interest rates, or the rates may be lower.
More so, private lenders tend to be more flexible about repayment schedules while still giving you quick access to capital.
5. Cash-Out Refinancing
This popular financing option allows you to borrow against the equity in an existing property. You then use it as a down payment on new vacation rental properties.
It’s in line with a Home Equity Line of Credit (HELOC)—a loan in which the financier agrees to lend a maximum amount over a set period. This allows investors to access funding as needed. You can take a loan to purchase your second home using the equity in your primary residence.
Other Ways of Financing and Purchasing a Short-Term Rental Property
Seek investment partners
Borrow from your retirement scheme such as a 401(k) or 403(b) plan
Choose the seller-second option
Go for the lease financing option
Key Takeaways
The truth is that financing a rental property investment can be an uphill task. Lack of down payment, lender blocks, poor credit, and more can hinder you from following the right path to financial freedom using rental properties.
Fortunately, there is a way around it with flexible financing alternatives. So, suppose you’re confused about how to finance your rental property investment or you want to expand your short-term rental portfolio; consider one of the financing options discussed above.
Owning a short-term rental property can offer investors, entrepreneurs, and lenders an excellent opportunity. With strategic financing, the potential for huge returns on your investment goes up.
Thus, before you dive into buying a vacation rental property, it’s crucial to understand all the financing alternatives. By carrying out your due diligence before signing any documentation, you can ensure that your rental property investment will pay off in huge amounts.
So, explore your options and remain open-minded. Take time to discover the financing alternative that works best for you. Investigate big financial institutions and local lenders, and check online opportunities to determine your ideal future investment.
Ensure you compare the financing options and understand what one will imply to you. Check aspects like interest rates, repayment schedules, and other essential factors for the successful operation of a short-term rental.
